K2 expects “material” ILS price dislocation after Ian, opportunistic entry point

K2 Advisors, the hedge fund focused investment management unit of Franklin Templeton, has said that in the wake of hurricane Ian it anticipates a “material pricing dislocation” across all segments of insurance-linked securities (ILS), which should lead to an “opportunistic entry point” to the sector for investors.

Summarising their view on ILS and catastrophe bonds, in light of losses from hurricane Ian, the K2 Advisors team explained, “Hurricane Ian has led to a significant dislocation and positive repricing across all ILS market segments. Performance has been historically strong in the aftermath of significant event activity which could materialize as we enter 2023.

“We expect to see material risk- adjusted rate increases ahead of the January renewals.”

The analysis from K2 Advisors’ ILS focused team goes into more detail as to how they see the market playing out as it moves towards the key reinsurance renewal season.

“How the ILS market will digest the impact from Hurricane Ian and how much counterparties and sponsors are willing to adjust to what is expected to be a significant reset in the price regime will largely define the January renewals,” they explained.

They highlight that hurricane Ian is expected to become the second most costly hurricane loss event for the insurance and reinsurance industry at least, likely behind Katrina’s $90 billion only.

Given the significant losses and ramifications for reinsurance and ILS instruments, including catastrophe bonds, the K2 Advisors team state, “The potential insured losses, on top of industry losses since 2017, will likely lead to a material pricing dislocation and opportunistic entry point.”

“Even before Ian made landfall the broader ILS market was already capital constrained, which could have attracted more opportunistic capital,” they continued.

Adding that the reinsurance cycle would imply that significant rate increases can be expected, in the wake of an event of the magnitude for the industry of hurricane Ian.

“Historically, following a large event the ILS market saw tremendous rate increases in subsequent years. We expect this dynamic to continue in a normal market environment,” K2 Advisors analysis explains.

They add an important point, especially relevant to those who feel rising rates elsewhere in financial market may damped demand for ILS.

“Additionally, as floating-rate instruments, the ILS market will benefit from continued rate rising,” K2 Advisors explained.

With rising reinsurance premiums and rising floating rates, the ILS market and catastrophe bonds are set to reach levels of return-potential not seen for well over a decade, it seems, future catastrophe loss activity allowing.

Finally, there’s been no change to K2 Advisors’ conviction on the different segments of ILS, with the investment manager remaining Neutral on the whole, but Strongly Overweight catastrophe bonds, private ILS transactions and retrocession investments.

In fact, those three asset subclasses from insurance-linked securities (ILS) are three of just six asset classes that K2 Advisors is Strongly Overweight on, in terms of conviction, at this time.