ILS capital rotation continues, but signs of growth across segment: AM Best –

Capital continued to rotate from one insurance-linked securities (ILS) instrument to another in 2023, but AM Best analysis suggests some sectors may becoming better primed for growth through 2024.

Overall, AM Best and reinsurance broker Guy Carpenter continue to estimate alternative capital in reinsurance deployed through ILS structures reached $100 billion at the end of 2023.

That was up by $4 billion from the $96 billion reported for the end of 2022 and, as we reported before, was higher than the two companies had estimated earlier last year, as the ILS market outpaced growth expectations in 2023.

The catastrophe bond market accounted for $42 billion of the total, with AM Best saying that heightened demand for reinsurance capital was a driver for growth.

But looking at the other segments of the ILS market, AM Best acknowledges that it continues to be challenging to estimate their sizes accurately.

The reinsurance sidecar market is estimated to have been between $5 billion and $7 billion at year-end 2023, which AM Best notes was “largely unchanged”.

On reinsurance sidecars, the rating agency said, “Investors are taking their time before reallocating to this segment, though harder rates underlying these proportional covers may begin to spark interest.”

Which suggests further growth for sidecars could be ahead.

As we mentioned in some of our reporting from the recent SIFMA ILS event, sidecars are getting more focus again, with at least one being marketed to investors around the conference.

Meanwhile, in industry-loss warranties (ILW’s), AM Best estimated that market segment as again between $5 billion and $7 billion at year-end 2023.

The rating agency noted that this is with, “Cedents less reliant on this type of capital at the January 2024 renewals because ultimate net loss retro providers stepped up to provide capacity.”

However, we understand that ILW trading interest has picked up in recent weeks, in particular between ILS funds, as portfolios are prepared for what is being seen as a potentially busy hurricane season ahead.

The final and still largest segment of ILS is collateralized reinsurance, which is estimated to be between $42 billion and $50 billion, by AM Best and Guy Carpenter.

“Capital moved out of collateralized reinsurance and into cat bonds, continuing the trend of the past few years. Recently, investors showed a preference for the remote risk layers,” AM Best explained.

But added that, “Collateralized reinsurance has moved up the risk tower as part of the de-risking efforts but still typically sits below the layers covered by cat bonds.”

We are hearing increasing chatter in the market about capital raising for the mid-year renewals, with large ILS investors seeking to access layers of reinsurance below where the catastrophe bond market sits, although still not as low-down as where collateralized reinsurance had dropped to in the past.

Demand is high in the layers below catastrophe bonds too, so there are opportunities for the ILS market to expand there, without affecting rates too much, it seems.

With strong returns secured in 2023, helped greatly by the shift higher in the risk tower, AM Best noted that, “ILS managers plan to pitch the accomplishments of 2023 to potential investors during fund-raising in 2024,” in the hopes of raising more capital this year.

The rating agency expanded by saying, “ILS managers say that the strong returns bolster the pitch that they will make to investors as they attempt to raise capital in 2024. Investors have already demonstrated a strong appetite for cat bonds, given the inflows in 2023. Thus far, they have not shown as much enthusiasm for allocations to collateralized reinsurance, however. ILS managers believe the 2023 returns will help strengthen the case for higher allocations, but investors may still wait to see if 2023 was a one-off or if positive returns are indeed sustainable.”

Additionally, ILS capital growth in collateralized reinsurance is more possible now as investors seek to expand allocations to the space.

AM Best said, of investors that entered the market for cat bonds in 2023, “ILS managers expect that some of these investors may look to branch out into collateralized reinsurance deals in a few years if the collateralized reinsurance market can sustain healthy returns during that time.”

Further explaining, “Enhancements to collateralized reinsurance contracts to include more substantial extension spreads to compensate for trapped capital may bolster investor’s willingness to deploy capital. ILS managers have also been educating investors on the structural changes made to collateralized reinsurance deals to improve results, such as higher attachment points, per event and per peril loss caps, and cleaner contract wording. Ultimately, resolving investor concerns will propel more capital inflows to collateralized reinsurance and achieve ILS managers’ goal to be a consistent source of capacity for the market.”

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