The cleanest ILS portfolios ever. Record issuance possible: K2 Advisors

The portfolios of reinsurance and retrocessional risk transferred to the capital markets, through catastrophe bonds and other insurance-linked securities (ILS), in 2023 are potentially the cleanest ever seen, while record cat bond issuance is a possibility this year, K2 Advisors has said.

K2 Advisors, the hedge fund focused investment management unit of Franklin Templeton, continues to have a particularly constructive outlook and strong conviction on investments into catastrophe bonds, private ILS and retrocession for 2023.

The manager believes the January renewal season was positive not just from a rate perspective, with some of the largest reinsurance price increases since just after hurricane Andrew seen, but also from the point of view of the composition of portfolios of risk transferred.

We’ve been highlighting the dramatically improved terms and conditions, as well as the reduced amount of aggregate structures in both the ILS and cat bond markets, which improve the return potential considerably and also mean often less risk is being assumed at far higher levels of expected return.

K2 Advisors explained that, “Pricing for US property catastrophe and global property retrocessional businesses hit multi-decade highs at the January renewals.

“Investors across reinsurance, retrocession and catastrophe bonds pushed backed on complex books, secondary perils and more complicated structures.

“The result is potentially the cleanest risk transferred to the capital markets, with a heavier emphasis on named peril coverage only and per-occurrence coverage as opposed to aggregate coverage.”

Demand for capacity continues to exceed supply at the January renewals, the investment manager’s team noted, while catastrophe bonds continue to have elevated spreads, which on top of the much improved money market rate means “attractive total yield potential.”

As we explained recently, there is evidence of spreads coming off their peak, but they remain at historically high levels and potential returns in the catastrophe bond market are dramatically improved on a few years ago.

The supply-demand imbalance is expected to continue in reinsurance and retrocession, K2 Advisors team believe.

While with flows to ILS and alternative capital strategies still limited, the market is seeing “potentially the most attractive risk-adjusted rates since the immediate aftermath of Superstorm Sandy.”

“Further buoying our positive outlook toward the ILS asset class is its floating rate structure. ILS instruments are priced as a spread above the risk-free rate. With a sizable increase in money market rates, the forward-looking total yield expectations remain near record highs,” K2 Advisors manager team state.

In catastrophe bonds, new issuance activity accelerated in March and Artemis’ data continues to show an elevated level of new cat bond issuance.

K2 Advisors forecast, “We expect this trend to continue into the second quarter as several brokers indicated 2023 could be a record year of new catastrophe bond issuance, exceeding the record US$12.5 billion issued in 2021.”

Adding that, “Despite the expected strong level of supply, cat bond pricing should remain robust.”