Amid the turmoil of the COVID-19 pandemic, rising interest rates, and the war in Ukraine, the insurance-linked securities (ILS) sector has held up well when compared to other asset classes, says Jeff Mohrenweiser, senior director at Fitch Ratings.

“We’ve seen other asset classes, such as bond funds and equity funds, lose double-digit values, but the ILS market fund managers have eked out a small gain or broken even, so it speaks to the diversification benefit of ILS funds,” he told Monte Carlo Today.

However, he sounded a note of caution: “We have to keep in mind that during this time, we’re running into the teeth of hurricane season, so this good performance could make a U-turn.”

Mohrenweiser said that amid the impact of the pandemic and the war in Ukraine, there have been record issuances in ILS, with nearly $8 billion issued in H1.

“This puts it on mark for the third highest issuance in history, so the market is ploughing forward,” he said. “That’s a healthy sign that it’s been able to retain capital.”

He noted, however, that investors are demanding an adequate risk premium for deals and in certain instances pulling back capacity.

“They’re cognisant of what’s happening in the Florida market with court cases, claim litigations, rising costs and so forth,” he said. “Investors are being more demanding and they’re willing to step away from deals if they feel they’re not being properly compensated.”

In the face of higher inflation, Mohrenweiser sees ILS investors as still in a position to benefit, or at least hold steady:

“Rising inflation will impact claim costs, and if there is an event, you might see higher claim payments coming through,” he said. “But on the flipside, the assets that are normally invested or used for ILS tend to be tied to something short-term, so interest rates will go up, and the coupon or the risk spread to investors will also increase accordingly.”

On the shift from traditional reinsurance capital to ILS, he noted that there is an ebb and flow in both sectors.

“If you experience enough pain, you start pulling back capacity and tightening up those terms and conditions. Florida hurricane is still top of mind, so you might see some pullback; I think we’ll see the traditional markets pull back a little bit more,” Mohrenweiser explained.

“But similarly, we’ve seen deals heavily focused on Florida that have not been placed in the ILS space, so I think the ILS market has sharpened its underwriting pencil, and they’re being judicious about making the right return for the risk they’re taking.”

Growth prospects

Looking ahead, he expects potentially 10 percent growth in issuance in 2022, in the absence of any large catastrophe.

“We see potentially similar activity in 2023,” he added. “The issue with ILS is they’re relatively short duration; they tend to have a maturity date of three, possibly four years. So if there was record issuance three years ago, we’re going to have a record maturity year.

“One of the breakthroughs for ILS would be to stretch out that maturity spectrum, to have some two-year, three-year, four-year, and five-year bonds—so you don’t always have this lumpiness with maturities.”

Mohrenweiser added that despite prospects looking bright for 2022, investors are aware that for four out of the last five years, losses have exceeded the 10-year average.

“Now people start thinking about climate change, and how is weather affecting the performance of these cat bonds, what the modellers are doing and so forth. Demand will be there, but we always have to be careful of things coming in from the side, such as climate change,” he said.

The ILS sector benefits from fierce intelligence and innovation, he added.

“There’s a lot of smart people in the space and they’ve risen to the challenges we’ve seen over the last 10 years.

“We always look forward to what’s around the corner. There are a lot of innovative ideas. We’re talking about cyber risk, about ESG, and potentially other casualty lines. They’re still in their nascent stage, but it shows that this space is vibrant,” he concluded.

Jeff Mohrenweiser is senior director at Fitch Ratings. He can be contacted at: jeff.mohrenweiser@fitchratings.com