In 2023, the insurance linked securities (ILS) market has learned from the recent natural disasters and perils that have affected its profitability. However, the current economic cycle with high inflation and interest rate hikes from central banks is still an impeding factor, said Sean Egan, Chief Executive Officer, Egan-Jones Ratings.
Egan was speaking at the ‘Risk Mitigation with Insurance Linked Securities: 2023 Outlook for Institutional Investors’ roundtable, hosted by Clear Path Analysis, in association with Tangency Capital, which has just been released as a report. In it, ILS experts from Risk Management Solutions (RMS), Albourne Partners, and Columbia Threadneedle Investments joined him in discussing what they have learned from a volatile 2022 – and how these lessons are relevant to the future of ILS.
“A lot of major institutional investors have embedded losses, and they
are trying to figure out how to deal with them.”
“The market is being disrupted right now due to the massive, unprecedented rise in interest rates,” Egan said when asked where he sees 2023 heading in terms of diversification and risk mitigation. “A lot of major institutional investors have embedded losses, and they are trying to figure out how to deal with them. In the meantime, there are pushes for reducing interest rates prospectively.”
These sentiments were backed up by others in the market, including the Bermuda-headquartered insurance law firm, Appleby, that released its Bond & ILS Market Q1 2023 report earlier this year, saying that “the general sentiment is that 2023 will be a good year for ILS, even with macroeconomic headwinds including inflation and a hard insurance market cycle.”
“I always think that the reinsurance industry is an alter ego for
the ILS market."
Egan said that the major drivers for inflation were easing in the first third of 2023, which would be reflected in the reinsurance rates. “I always think that the reinsurance industry is an alter ego for the ILS market,” he added.
The Appleby report further specified that the total number of new insurance linked securities issued in the first quarter of 2023 beat the amount issued in the fourth quarter of 2022, with close to $1.7 billion of new ILS issued between January and March 2023. At approximately $3.3 billion, first quarter 2023 catastrophe (CAT) bond issuance is above the ten-year average for the period, it said, although this was still below the record $4.1 billion seen in Q1 2020.
Egan added, however, that a lot of reinsurers are laying off their risks – and the rosy issuance picture only told half the story. “The fact that reinsurance rates have increased dramatically suggests that they perceive the risks to be higher, that their funding costs have increased, and that they have difficulty laying off those risks,” he said. “You could infer that they also perceive the risks to be higher, but I don’t see this because good luck predicting when the next earthquake is going to happen.”
“It is not just a couple of tourist hedge funds that are looking for quick pop-in
returns; it is those who will be there regularly."
“The market is dealing with and absorbing these major factors,” he said, adding that there is a need for broader, more efficient capital in this space. “It is not just a couple of tourist hedge funds that are looking for quick pop-in returns; it is those who will be there regularly,” he said.
Others in the market echoed Egan’s views. Schroders said it its 2022 “Insurance-linked securities: diversification and returns” report that it believed investors would be wise to consider diversification through a new lens.
“Rising yields may mean the diversification benefits provided by government bonds are materially different in the future,” said the report’s author, Zeba Ahmad, Alternatives Director at Schroders. “At the same time, risk assets may carry hazards that require new understanding as a result of central bank actions and weaker connection to fundamentals.”
Egan concluded by saying that there is a significant need for attracting new capital, and inflation will continue to drive costs up. “From the investor’s perspective, 2023 is going to be an attractive market,” he said. “You already see this in the reinsurance rates – and from someone who is trying to lay off risk, it is going to be more expensive.”
