Capital raised YTD still far below level needed to soften the cycle: J.P. Morgan

Capital raised in reinsurance and insurance-linked securities (ILS) year-to-date remains far below the level required to threaten the current hard market cycle, according to analysts at J.P. Morgan.

The analysts from the investment bank say that the scarcity of capital seen has certainly helped to harden reinsurance pricing, but also note that there is a need for reinsurers to earn payback after the significant losses they’ve suffered over years since 2017.

However, they don’t believe capital raising so far this year comes close to reducing the scarcity factor, so are confident that reinsurance won’t materially soften right through 2024.

“We would be surprised if the market began to materially soften in 2024 given the need for the industry to generate payback after a difficult few years and below-average returns,” the J.P. Morgan analyst team said in a recent report.

Adding, “The key piece of evidence to us is US property catastrophe prices reaching their highest ever levels according to data from Guy Carpenter following the mid-year 2023 renewals; had capital been flooding back into the sector, we do not believe that prices would have sustained their strong run YTD.”

In addition, while the catastrophe bond market has seen strong growth, with significant issuance seen in the first-half of the year, the analysts note that much of this has been in refinancing existing covers rather than net new issuance, also saying that cat bonds are not always in direct competition for traditional reinsurance layers.

“Catastrophe bonds generally only cover tail risks and are not a natural substitute for most reinsurance covers, but are capital optimisation tools that offer attractive returns with only a remote chance of being triggered, in our experience,” the analysts wrote.

Further explaining that, “We have seen YTD that, whilst catastrophe bonds have seen some inflows, collateralised reinsurance business, which was a more direct competitive threat to the traditional market, has not seen a similar trend.”

The analysts continue to believe that catastrophe bonds are likely to be the near-term beneficiary of the most inflows into ILS, with collateralized reinsurance slower to recover.

Noting, on ILS as an asset class, “2023 has been a good year so far, but using a 10-year track record, the returns have looked less attractive on average. Once this track record improves, we expect more capital will come to the industry, but we see such a shift as unlikely in the near term.”

It’s further positive commentary on the prospects for reinsurance to remain in a state of hard pricing, with not much softening expected to be evident until capital flows in more meaningfully.

While the analysts point to rates through 2024 remaining relatively stable, it is the end of this year’s fundraising efforts that will influence the renewal pricing the most and with significant efforts to attract new capital already underway, a lot will rely on the success of such efforts and how much capital ILS fund managers can attract, it now seems.