Ready for liftoff
Fuelled by the hard market, the insurance-linked securities (ILS) market is poised to expand in 2024 after a successful 2023, says Hiscox Re & ILS’s Vincent Prabis.
Prabis, who has been part of the ILS sector since its inception 25 years ago and is now managing principal for Hiscox ILS, believes that after several years when the market plateaued, it is ready to grow again.
He says rising rates, tightened terms and conditions and the prospect of solid returns for investors have combined to bring investors back into the market.
The ILS market grew rapidly in the early 2010s, reaching $97 billion in capital in 2018 from $65 billion just four years earlier, but then struggled to break the psychological $100 billion mark as catastrophe losses deterred new investment.
That changed in early 2023 as the hard market took hold and the $100 billion barrier was broken in the first and second quarters of the year.
Now Prabis believes more growth is likely. “We are in a generational hard market and the performance we are seeing among property and casualty reinsurers has carried over to the ILS sector,” he says.
“The hard market is here for three reasons. First, capital remains quite constrained. Second, the world is an increasingly risky place geopolitically and macroeconomically. Finally, we have experienced a heightened loss environment for natural catastrophes over the past several years.
“Those conditions are still very much present, and we believe they will continue into 2024. That means the hard market is likely to persist,” he says.
Interest rate challenges
Prabis concedes that increases in interest rates in 2022 caused challenges for the ILS market, but they were not insuperable.
He says the challenge of higher interest rates has been twofold. First, the decline in investment markets as a result of interest rate hikes meant that investors had to reallocate their holdings. Second, Prabis acknowledges, as institutional investors benefit from higher risk-free rates, they are taking a fresh look at their allocations to alternative asset classes.
He notes that 2022’s selloff in the bond and equity markets created a denominator effect which meant investors had to rebalance their portfolios, and this would have an effect on the ILS market. Despite that, he says, there is a silver lining.
“As we speak to prospects, we are in a position to tell a positive story about performance and diversification.” Vincent Prabis, Hiscox Re & ILS
“It is true that capital constraints are a factor for investors at the moment, following a prolonged period of losses due to high cat years. But allocators still need to demonstrate diversification in their portfolios.
“That diversification is hard to find and it is one of the key strengths of the ILS asset class. Another strength, particular to Hiscox, has been our fund performance.
“Our funds are generating record returns, a reflection of the reinsurance portfolio Hiscox is underwriting. So, as we speak to prospects, we are in a position to tell a positive story about performance and diversification. It makes for a very compelling investment proposition at the moment.”
“They can access the market using a rated balance sheet and this gives them additional leverage.”
Different strokes
Prabis agrees that different investors have different approaches to the ILS market, from those who are new entrants to the market to past investors contemplating a return.
“Some investors are waiting to see further momentum from the hard market before re-entering, while others recognise where we are in the cycle, especially given our strong performance, and they are looking to enter the market.”
Looking to 2024, Prabis notes that potential ILS investors are more focused on liquidity. “We are now seeing the interest shifting to more liquid accessible products from fronted traditional reinsurance.”
“In the recent past the cat bond sector has had the most inflows for three reasons: (i) cat bonds offer a relatively high degree of liquidity; (ii) they are accessible; and (iii) their performance has been relatively good.”
More growth ahead
Prabis is optimistic about further growth in the ILS market, because the hard market looks set to continue and, at least with regard to terms and conditions, the changes put in place since 2022 may be permanent.
He notes that both the reinsurance market and the ILS sector have been relatively unaffected by natural catastrophes, despite the fact it has been an active year with more than $100 billion in claims, and because severe convective storms have cost more than $50 billion.
“Going back to how hard the market is, most investors are aware that the optimal way to access the reinsurance risk is through fronting vehicles. Our investors benefit from our closely aligned model between our ILS arm and our reinsurance business, which means the Hiscox Re & ILS underwriting team evaluates every treaty utilising what we call ‘the Hiscox view of risk’.
“This provides additional reassurance to investors that they are supporting a high-quality portfolio,” he explains.
Prabis says fronted reinsurance is attractive to investors because it offers them diversification and higher potential returns.
“Apart from being able to access the broader spectrum of risk, which in turn gives them more diversification in their portfolio, they can access the market using a rated balance sheet and this gives them additional leverage, which at the moment, allow them to be better remunerated for a lower risk.”
Prabis says Hiscox ILS’s outlook is in line with the general market, helped by the fact its parent company allocated more capital to its reinsurance operations earlier this year.
“That was a very strong signal sent not just to the traditional market, but to our ILS partners, that sees that the aligned model works,” he says.
“With the current results we’re delivering and the diversification benefit of the ILS class being reaffirmed once more, the future is promising.”
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