ILS Market Update

According to Aon, as at 30 September 2017, reinsurance capital has grown to $600bn, with just over 13% - $82bn - coming from alternative markets, such as ILS funds and collateralised reinsurance companies. However, these numbers are very small when compared to the size of other capital markets. In December 2017 Bloomberg estimated the global equity market capitalisation at ca. $65 trillion and the debt capital markets at over $100trillion. It is these debt capital markets investors with $100 trillion of capacity and over $1 trillion of daily turnover that have taken an interest in (re)insurance risk investment as a diversifier offering them increased yield while participating directly in insurance risk outcomes. Their involvement has been initially via ILS funds but some larger investment houses have been building internal expertise to manage and participate in these risks.

“My next door neighbour is having a party - I want to join”

(Re)insurance companies accessing the debt capital markets (DCM) are benefiting from substantial demand and favourable market backdrop. Interestingly enough, investors are willing to go into “riskier” asset classes and/or longer maturities in their quest for yield. Some recent notable examples include:

• In November 2017, Talanx AG placed a €750 million Tier 2 bond with a fixed coupon of 2.25% and a first call date of Dec 2027 (10 years). This was equivalent to Market Swaps + 145bps which is the lowest ever spread on an insurance Tier 2 bond and the second lowest coupon (after Allianz’s reported 0%). The book, as expected, was significantly oversubscribed.
• In March 2018, the market went a step further with SCOR placing a $625m RT1 transaction - the transaction, which could be described as “niche”, was the first Solvency II compliant tier one bond to be issued in dollars, and the first in any currency from a French insurer (It also had an investment grade rating “A”). The pricing process was a testament of the appetite out there; From initial price thoughts in the 5.75% area, guidance was in the 5.375% - 5.5% range and final terms were set at 5.255% with the unreconciled order book standing at more than $3.75bn.

So the key question that (re)insurance companies should be asking is “ can I leverage / convert this appetite for risk into my “niche” (re)insurance / ILS space?”

“ILS market is developing as well - but the pace is killing me”

The current ILS market is focussed on property catastrophe risk, mainly on the US East Coast and in the Gulf of Mexico, which have been independently modelled. The ILS market is definitely taking steps in the right direction with investors and (re)insurers both willing to look into new classes and diversified risk pools; the problem however is that the pace is too slow as the ILS market remains too “niche” / small. Recent interesting developments include:

• Leadenhall Capital Partners LLP has launched a new remote risk ILS fund strategy that targets more conservative investors, with $22.5 million of capital secured at the start of the year. The fund targets a return to investors in a range from 3% – 4%. We believe that this is a step in the right direction as it enables investors with a less technical / more holistic investment view to participate in insurance risks without requiring a PhD in actuarial sciences to understand the risks.
• Pool Re is actively exploring on whether it can use ILS to expand its sources of terror retrocession to the capital markets. An ILS vehicle could provide cover for specific layers of Pool Re’s risk, or a number of different segments with differing attachment probabilities to match their investors risk appetites, offering the terrorism reinsurer significant flexibility in its retro program along with price competition and a reduction in credit exposure to traditional (re)insurers and a reinsurance capital raising platform it could develop and grow. While we support this product and clearly recognize its merits, we see educating investors on the risk and getting them comfortable with assessing the risk as the biggest hurdle.
• Nephila Capital is expanding its role in weather, climate and environmental, social & governance risks with the launch of a dedicated unit, Nephila Climate. The size of the opportunity is significant, as weather protection can enable commercial and government entities better manage their climate resilience risks that are related to weather volatility and extreme weather across industries and sectors including logistics and transportation, construction, mining and minerals, food and agriculture, hospitality and retail.
• Substantial capital has been raised by the Legacy sector of insurance business with (re)insurers passing on tranches of business to the participants in this market, saving them capital and taking advantage of the specialist business knowledge in this area - Zurich being the latest announcement in this area with a {$500m} asbestos book being put up for sale, with more to follow.
• There have been announcements from AXA and Lloyd’s of an intent to tap debt capital markets as part of their longer term strategy for M&A or capital support. This trend is expected to continue given the current active M&A phase in the specialty(re)insurance sector and the continuing very low interest rate environment.

The current environment is encouraging the convergence and incorporation of the insurance linked securities market into the mainstream debt capital markets

From Vario’s perspective, investor appetite has expanded beyond tiny participations in dedicated ILS funds with those investors who participate in (re)insurers debt programs also looking to participate directly in insurance risk outcomes via ILS or similar transactions. Convergence for investors is therefore following two paths - For some, they are adding incremental event risks / (e.g. cyber, climate, flood and potentially terrorism) using techniques and approaches that ILS funds are most familiar with. For other investors the route expands their analysis from (re)insurance subordinated debt and similar transactions that look at (re)insurance company activity on a holistic basis, (which is what DCM investors have been familiar with), and start decomposing this into individual pools of risks.