Alternative thinking: the historic rise of ILS


Aon Securities has published its annual ILS report: Alternative Capital Breaks New Boundaries. Paul Schultz, its chief executive, tells SIRC Today about the key developments during what has been a record year for ILS.

It has been a record year for insurance-linked securities (ILS) in several ways. In the six months to June 30, 2017, some $8.5 billion of catastrophe bonds had been issued—far higher than even the most bullish estimates at the start of the year, and exceeding any annual issuance total on record.

Paul Schultz, chief executive of Aon’s investment banking team, Aon Securities, says that even his own forecast of around $8 billion issuance for 2017, which was viewed by many at the time as optimistic, had since proved to be too conservative.

He explains that the higher-than-expected levels of issuance had been partly because some of the deals launched in 2017 were upsized significantly due to strong investor demand, including a couple that eventually exceeded the $1 billion mark.

“The competitive pricing environment has resulted in some issuers reconsidering their ability to issue larger deals; there is an even greater realisation that ILS can be a very cost-effective form of protection,” Schultz says.

He explains that pricing in the cat bond market has softened in the past 12 months and especially since the third quarter of 2016.

“Relative to other forms of coverage, prices have decreased and that has also boosted the growth of this market in late 2016 and into 2017,” he says.

Despite this, he still characterises the ILS market as complementary to so-called traditional reinsurance.

“We advise clients across the scope of execution, but we do not see one as displacing the other,” he says. “ILS is competitive and there is a great amount of capital available, but this is also a market leveraged by reinsurers, so it is not as simple as seeing it as straight competition.”

Capital entering

Schultz explains that increased investor interest in this field has been driven by capital-raising efforts in this sector that often started some two years ago.

“As managers saw rates stabilise in the ILS sector, there was a real push to raise money and those efforts are now coming to fruition,” he says.

“There is a natural lag between marketing efforts and capital inflows into the sector, but we are now seeing new investors as well as an increase in allocation from existing investors. Given that we saw deals in the second quarter of 2017 pricing as aggressively as in the first quarter, we believe that there is still plenty of capital on the sidelines waiting for an opportune time to come in.”

He stresses that many investors are entering the sector for the long term, valuing the non-correlated nature of ILS as an asset class, but also aware of the type of events that could lead to losses on the bonds.

“Investors understand that the cyclical nature of the industry means that to maximise their returns, they have to be in the market long term. If they pulled out after an event, they would lose the opportunity to earn better returns. That leads us to believe that most investors will still be there post-loss,” Schultz says.

He stresses that insurers and reinsurers are increasingly using ILS as a tool to help them manage risk, and their own cost of capital, in a very dynamic way.

“Alternative capital is relevant to both insurers and reinsurers. Given where capital is being priced, this can be an efficient way of managing a balance sheet. It is a strategic tool that helps re/insurers leverage their capital, manage their balance sheets and help accelerate growth.

“Re/insurers have moved past the idea of this being competing capital and they see it as complementary to what they do. They are looking for ways to harness what is available.”

Schultz says that the annual ILS report outlines that both returns and relative returns in ILS mean that it remains a very attractive place to deploy capital. This is also a trend that is unlikely to change overnight.

“We are very bullish about this sector, and our annual report reflects that view in the trends and discussion points it highlights,” he says.

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