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The growth of alternative capital in reinsurance, catastrophe bonds and insurance-linked securities (ILS) as a whole seems assured, but how fast it will grow remains uncertain and many factors could stimulate more rapid, or slower growth, but EY estimates it could make up 28% of reinsurance capital by 2021, or around $224 billion.
In fact this is a conservative estimate from EY, as the firm clearly feels that there is every chance ILS capacity could grow even faster over the coming years.
Others believe that traditional reinsurance and ILS capacity could be reaching more of an equilibrium point meaning the ILS sector needs to innovate to expand, in terms of share of the overall reinsurance market. But EY is bullish and anticipates that the ILS market will continue to find new avenues for growth and expansion.
Projected development of (re)insurance capital structure by 2021 (conservative scenario) – Source: EY analysis, Aon Benfield Analytics data
EY believes that alternative capital and ILS can grow at a compound annual rate of 22% over the coming years, which would take it from the 14% of reinsurance capital it contributed in 2016 to the 28% or more they predict by 2021.
After recent catastrophe loss events there is a lot for the ILS sector to work through, before growth will continue at this pace, we believe. But if the ILS sector can come out the other side of recent losses having paid its claims and found even more opportunity as a result, the growth rate may even be quicker in years to come, although it could take a while for the fallout of the catastrophe losses to be dealt with. EY’s forecast came out prior to this years devastating hurricanes.
EY notes that future increases in interest rates could slow down the rate of ILS and alternative capital growth, but the firm believes that this will be “more than offset by enhancements in the sophistication, product horizontalization and appeal of insurance-linked securities (ILS).”
EY sees platforms for risk transfer as part of the ILS market’s future and something that will help it to grow, as these would “facilitate the transfer of risk to the capital market, increasing market access and reducing costs.”
Additionally, the horizontalization of ILS means ongoing “expansion of ILS products to cover new perils and regions.”
While at the same time EY says the “confidence of investors in ILS is growing steadily as they recognize the bene ts in terms of diversification and risk-adjusted returns.”
All of this points to ongoing growth for ILS and therefore continued acquisition or reinsurance market share from traditional players. That’s not even including the potential for traditional insurers and reinsurers to increase their use and management of third-party capital as well, which could accelerate following recent major catastrophe losses.
“Reinsurers can tap into substantial efficiency gains by improving their capital structure by embracing alternative capital,” EY explained. “They can lower their cost of capital by securitizing peak and capital-intensive risks (especially standardized risks). Insurance-linked securities, in particular, provide an efficient solution for transferring such risks.”
EY also notes that ILS and the capital markets offer, “An efficient solution for remedying the mismatch between supply and demand, as a liquid marketplace can improve pricing transparency, accelerating the trial-and-error phase needed to accurately price difficult-to-value risk whenever there is a lack of historical data.”
The capital markets have a huge role to play in the future of insurance and reinsurance, as the risk transfer market increasingly moves towards once where transfer of risk is increasingly efficient, demanding the lowest-cost of capital be leveraged to pass on the benefits to the policyholder.
EY’s growth forecasts seem perfectly reasonable at this time, although recent events do have the potential to push them back a little. However the way the ILS industry is responding to recent losses also has the potential to stimulate additional growth, so targets for market growth may even rise once the dust settles.