Are property cat rates a headwind for non-cat ILS growth?

With property catastrophe reinsurance rates and pricing having soared in recent months, rating agency AM Best sees this as a potential headwind for the burgeoning non-cat insurance-linked securities (ILS) segment, as investors focus may shift back to catastrophe risks.

Investor interest in accessing insurance and reinsurance linked returns from alternative lines of business, outside of the more typical property catastrophe and severe weather risks, has increased through recent years, with the losses faced one of the drivers for that interest.

In the wake of five or more years where losses have affected the returns of catastrophe reinsurance focused ILS investments, investors have been increasingly open to looking at other lines of business where insurance or reinsurance returns can be generated.

Of course, the ILS market has long been looking for line of business expansion. It’s been a topic of discussion at every ILS conference for more than a decade, but progress has been very slow.

It’s only in the last few years that things have begun to accelerate, with the challenging loss environment in property cat one driver for growing investor interest.

But, with property catastrophe reinsurance rates-on-line back near highs, while terms and conditions are tighter than they have been for more than a decade, AM Best believes investor focus may shift back onto cat risks, to the detriment of the growth of non-cat ILS.

“There may be near-term headwinds for non-cat ILS expansion,” AM Best explained in a recent report.

Adding that, “The recent improvement in property catastrophe pricing and terms and conditions may prompt investors interested in the diversification benefits of ILS to deploy capital into the more well-known property cat market, instead of non-cat ILS.

“In an attempt to woo such investors, some ILS market managers are making a pitch that the property cat market has never been as attractive as it is right now.”

Of course, this is a completely true statement by those ILS managers. Property catastrophe investments are perhaps at their best pricing and terms on-record.

As we reported last week, catastrophe bond spreads have reached a record based on our data-set that goes back to the beginning of the market.

Combine that with the improved terms, higher attachments and other feature improvements, and it’s clear cat bonds are about as attractive an investment as they ever have been.

But, at Artemis we don’t believe that the improved return potential of catastrophe risk investing slows the non-cat ILS wave of interest.

In fact, while investors are likely to allocate more capital back to catastrophe risks again, the fact it is becoming increasingly accessible to diversify within the insurance and reinsurance space, is only going to result in more capital flowing to non-cat ILS strategies as well.

Non-cat ILS is achieving a level of interest that should sustain its growth, as a segment of ILS investing.

In addition, non-cat ILS is attractive to investors that have not looked at natural catastrophe ILS before, as they are attracted for different reasons, the return profile, and in some cases the asset side of the insurance balance-sheet that certain non-cat ILS strategies can make more of a focus.

AM Best points to the traction Ledger Investing and Multi-Strat are both making in the space, to which you need to add Vesttoo, ILS manager Hudson Structured which has had a non-cat focus for years now, traditional re/insurance market players like Aspen and AXIS are finding ways to share risks with investors, as well as RenaissanceRe with its Fontana casualty/specialty third-party backed structure.

In addition, we’d put cyber risk into the non-cat ILS segment as well, an area of the market that is set for strong traction it seems.

The key to growing the non-cat ILS space has always been about traction.

Until a reasonable number of deals are completed and a range of investor access points are available, you’re never going to develop a sustainable market.

But now, there are numerous ways investors can access non-catastrophe ILS investments, multiple deals are getting done and the landscape is beginning to form, much like it did in property catastrophe risks back in the late 1990’s and early 2000’s.

Non-cat ILS remains nascent, a new market segment, but it is increasingly being accepted as here to stay, while those players already making headway, like those named above, are now positioned to lead the growth of this diversifying segment of the ILS marketplace.

AM Best also noted in its recent report that a secondary market will be key for the growth of the non-cat ILS segment.

Which is valid, but how liquid non-cat ILS with longer durations will ever be remains a bit uncertain.

While cat bonds are tradable, the larger collateralized property catastrophe reinsurance asset class grew without a secondary market and non-cat ILS looks more likely to end up largely in private collateralized deals, than fully securitized notes with secondary transferability, for now at least.

So, while a liquid secondary market certainly can help to broaden accessibility of the non-cat ILS market, unless that is a secondary market with true interest on both sides and where the price is not getting set by those originating and structuring deals, it’s not really likely to be particularly liquid for the moment.

In future, we’d hope that true secondary liquidity (trading) becomes a more prevalent feature of all of the ILS market, across private catastrophe risk deals as well as non-cat ILS, as that would benefit the whole ecosystem.

For over two decades now I’ve been speaking with investors interested in tapping insurance and reinsurance market returns through ILS securities. The subject of whether an expanded range of insurance risks will become available to investors has featured for all of those years.

Growing non-cat ILS has always been about finding the methods, mechanisms, structures and business models, as well as technology, to make this possible, more so than where rates sit in other areas of the market.

We’re now at a stage of non-cat ILS development where investors can really get involved and at increasing scale, so on that basis it seems both here to stay and likely to continue to expand, no matter where property cat rates head.

A great example of this evolution of the non-cat ILS space is the recent transaction from Vesttoo that we covered, which shows non-cat ILS moving on to a new stage of its maturity as the tech-firm seeks to arrange a first investment grade non-cat casualty bond.

Moves like this suggest non-cat ILS will continue to grow as a component of overall ILS and with investors seeking out diversification within ILS that bodes well for everyone involved in the asset class.