ILS proves its durability

After a period of uncertainty and dislocation for the wider risk transfer markets, the insurance-linked securities (ILS) market in particular has adapted and helped the wider industry recapitalise, and has played an important role in helping it stabilise and continue to support clients. On the back of this, the second half of 2023 and 2024 are looking robust for the ILS sector.

That is the perspective that Paul Schultz (pictured), chief executive officer of  Aon Securities, offers when asked to summarise the dynamics in the ILS market as the industry meets in Baden-Baden.

“What has been interesting is the evolution of the buying strategy of our clients,” he adds.

“Historically, there has been a tendency to access the ILS market only if it provided a cheaper cost of capital. But what we have seen throughout the most recent market cycle is that our clients, especially our European clients, are taking a more holistic and strategic approach to the ILS product.”

Schultz highlights that during a hardening market, ILS can provide clients with leverage across their reinsurance programme, by enabling them to access a pool of capital that ultimately makes up 15 percent of the reinsurance market. He notes that the ILS market has helped the wider industry prove its durability and sustainability through stressful periods.

“Activity levels are elevated from historical perspectives, and that is a result of a number of factors last year, including Hurricane Ian. Insurers have looked to diversify their sources of capital, and the ILS sector was able to recapitalise quickly and bring that capital to bear.

“That brought some calm to our market, which has resulted in a higher level of activity,” he says.

“We’re catching our breath now after a busy first half of the year, but looking forward to the second half. We expect an elevated amount of issuance in 2024 as well. The capital has had a stabilising effect on the ILS market, but more broadly across all reinsurance markets.”

Schultz says this dynamic has meant a renewed drive into innovation for the sector, as companies sought solutions they had perhaps not considered previously.

“When you go through periods of dislocation or stress in the marketplace you tend to identify new solutions and new ways to grow. The challenge creates the opportunity. Going through the 1/1 2023 renewal, there’s no question there was duress and stress in the marketplace.

“The founding principle of the ILS market was always diversification—of capital sources or capacity. So when the market can respond in this way, it highlights the principles of why the market was founded in the first place,” he says.

“As insurers prepare for the next event—and there will always be another event—they have diversified their capital sources. The range of capital solutions now available helps cedants to trade forward post-event, and drives a more strategic capital allocation and optimisation process and, ultimately, better business decisions.

For us, the diversification theme has resonated quite well with clients, including reinsurers looking to create more capacity options for their clients. As part of our discussions with cedants, we outline how the inclusion of ILS into risk transfer programmes can help them to navigate volatility and build, or maintain, business resilience.”

This has resulted in potential innovation in other ways, Schultz says. More businesses are now exploring ILS, he says, as are some governments, while structures are being developed to transfer other types of risks such as cyber.

Challenges ahead

There are some headwinds. Schultz highlights inflation as one, which has meant a big increase in property values, thus increasing the underlying exposure. The challenge for the ILS markets was how to factor this into deals. Currency fluctuations became another issue. Then, losses from Hurricane Ian compounded some of these challenges in 2023.

“Looking at last year, those headwinds were significant. We saw quite significant movement in return expectations and impacts on valuations. But the market adjusted well and was able to recapitalise very swiftly, bringing new capital in,” he says.

Schultz stresses that this remains a cyclical industry—some cycles are elongated, some are shorter. But in terms of the returns ILS has offered investors, the returns generated over time have been very consistent.

“I’d say cat bonds have generally outperformed other collateralised strategies. Therefore, when new capital flows in, cat bond funds tend to have been the initial recipients,” he says.

“When all collateralised forms of risk transfer are combined, the sector now offers more than $100 billion of capital, and has reached this landmark thanks to recent fresh capacity.

“That is a healthy indication of what we can expect going forward, and as we look to the pipeline for the remainder of this year and for 2024, we’re very encouraged about the progress we’re making. We’re very optimistic,” he concludes.

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