Very attractive ILS returns expected through coming years: SIGLO

The insurance-linked securities (ILS) marketplace is expected to remain an attractive place to deploy capital over the coming years, with “very attractive” returns expected to persist, according to SIGLO Capital Advisors AG.

The Swiss based alternative asset advisory specialist that has an insurance-linked securities (ILS) practice believes that while an equilibrium may be found, in terms of reinsurance capital supply and demand, returns possible from investments in ILS are likely to remain higher than had been historically seen.

While it’s clear that “2023 can be considered a success for ILS investors”, SIGLO Capital Advisors notes that the market is still in a situation where “Encouragingly the starting position for ILS is not significantly different today than it was 12 months ago.”

“Inflation rates in Western countries remain high despite declines. Increased inflation expectations in the USA and the associated interest rate expectations (“higher for longer”) will continue to drive demand from insurance companies for reinsurance cover, particularly at the upper end of the capital structure. At the same time, rating agencies and regulators are demanding more extensive capital requirements for (re)insurers, which will be reinforced by model updates from some risk modelling agencies. Traditional reinsurance companies will therefore not be able to satisfy the demand for insurance cover on their own,” SIGLO explained.

Adding, “In general, the imbalance between demand and the supply of reinsurance capital is expected to continue, but probably not quite as pronounced as it was a year ago. The market consensus is, therefore, that the trend of positive premium development will continue in 2024, albeit at a weaker pace than in 2023.”

If the underwriting year in 2024 across reinsurance is similar to 2023, in terms of loss activity, SIGLO expects that “the market dynamic between supply of and demand for risk capital in the reinsurance and ILS market will probably return to a balance.”

But the advisor further explains that, “Despite the assumption of a normalisation of supply-demand dynamics and the gradual return to historical averages for risk premiums and margins, very attractive returns can be earned with the ILS asset class over the coming years. Specifically, with a balanced ILS risk/return profile, a return of 11.0% to 13.0% (gross in USD) can be expected for 2024, depending on liquidity requirements.”

In fact, SIGLO believes that, for a balanced ILS risk-return profile strategy, depending on the liquidity of the allocation, investors can hope to earn between 8.5% and 10% p.a. (gross in USD) on average from 2025 to 2027.

Reinsurance remains in a hard market phase and there is no appetite for a return to the softening seen in the previous decade, it seems.

As we’ve explained, reinsurer resolve is strong and while a far more stable renewal market has been seen for the January 2024 contract signings, moderation of pricing has not been overly significant even at the most competitive levels in the risk tower.

In catastrophe bond investment strategies, SIGLO believes that an average return over the years 2024 to 2027 could be around 9.2% gross in USD per-annum, with as much as 11.4% achievable in 2024.

That aligns with other forecasts, such as Plenum Investments saying double-digit returns are likely in 2024 for cat bond funds.

For a broader ILS investment strategy, so one that includes collateralised reinsurance instruments as well as catastrophe bonds, SIGLO anticipates around 13.1% in gross USD returns for 2024 and a 10.9% average across 2024 to 2027 per-annum.

All of this while maintaining the typical attractive features that investments in the insurance-linked securities (ILS) asset class are known for, of low correlation, diversification and now also attractive returns.

The outlook for cat bond and broader ILS investment returns depends greatly on the state of the insurance and reinsurance market and whether any softening seen around the turn of this year becomes more persistent again, with capital inflows a key driver of those trends.

For catastrophe bonds, SIGLO cautions, “If there are relatively few claims in 2025 and 2026, this will lead to a build-up of a capital buffer for protection buyers, which is likely to result in a reduction in risk premiums. During the last soft market phase (24 months: 2020 – 2021), premiums fell by around 21%. We assume a decline in premiums of around 10% p.a. for both 2026 and 2027.”

On the private ILS side, so where collateralised reinsurance and other instruments are underwritten and invested in, how attractive these are will be driven by the resolve of the reinsurers and ILS managers to hold onto the hard-won terms and conditions, such as attachment points, as well as price.

SIGLO states, “If the years 2025 and 2026 tend to have few claims, a decent return will be achieved, and a corresponding capital buffer will build up. The latter typically heralds a phase of decreasing premiums. In the last “soft” phase of the market (2012 to 2017), premiums fell by an average of around 7% per year. We use a slightly conservative assumption with a premium change of -7% for 2026 and -10% for 2027.”

So, softening is being predicted, albeit not at such a level that would take ILS returns down to the depressed levels seen before the current period of hardening began.

As a result of which, SIGLO expects ILS returns will remain more attractive than they had historically been prior to the beginning of the hardening that began from around 2018.

As for why ILS should be considered by investors, SIGLO explains, “In addition to the attractive returns expected now and in the foreseeable future, it is important to emphasise that the ILS asset class is one of the few fundamentally and causally diversifying asset classes in an overarching investment portfolio context. This is due to the fact that neither the occurrence nor the severity of insurance events (as the driving risk factors of ILS investments) are dependent on the dynamics of the financial markets.

“Whether an insurance event occurs or not does not depend on the state of economic indices or markets. Although the development of hard and soft markets is not entirely independent of financial market developments, it is certainly not directly driven by them.”

With “various economically plausible arguments that offer a very positive outlook for ILS investments,” SIGLO believes that right now ILS investing, “deserves a glimpse of attention in upcoming ALM studies of institutional investors, not only as a source of attractive returns, but also as a “naturally suitable diversifier” of traditional investments.”

“In our view, it should therefore be worthwhile for ILS investments to play an active role within the SAA of institutional investors in the near and medium term,” the investment advisor explains.