Best's Review


A Pause After the Storms

Following two years of painful catastrophes, ILS investors are waiting for claims to be paid so capital can be released. However, they remain committed to the market.
  • Jeff Roberts
  • August 2019
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Key Points

  • Flood of Capital: ILS in-flows have surpassed $100 billion from just $18 billion in 2009.
  • Lean Years: But ILS investors have grown cautious after losses in 2017 (-5.60%) and 2018 (-3.58%) due to a series of natural catastrophes.
  • ILS Investment: (Re)insurers are betting on ILS, as AIG, Markel and Scor recently acquired fund managers, and Allianz subsidiary Pimco launched its own ILS business.


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The flood of capital rose year after year, pouring into insurance-linked securities.

More than $93 billion had flowed into the ILS market by the end of 2018, an exponential surge from $18 billion in 2009, according to Willis Towers Watson. It recently broke the $100 billion barrier.

Besides the massive in-flow, ILS funds delivered dependable returns, averaging nearly 5% annually for more than a decade.

But then came 2017 and hurricanes Harvey, Irma and Maria. And then came 2018, and Hurricane Michael, Typhoon Jebi and particularly the California wildfires.

Those events left billions in trapped capital waiting for the losses to be tallied and the claims paid. After two straight difficult years, investors have grown cautious.

“Investors' confidence in the market was clearly shaken over the course of the past two years,” Rick Pagnani, executive vice president and head of Pimco's ILS business, said. “While the asset class still represents an attractive alternative investment, ILS investors have learned a hard lesson on the importance of manager selection.”

As a result, many fund managers struggled to attract new investors and retain existing ones to replenish the Jan. 1 renewals and reinstate their positions.

The 2018 losses and a capacity crunch in the collateralized property cat retrocession space—precipitated by investors seeking higher returns and tightening terms—drove up pricing, according to the February Best's Market Segment Report, Reinsurance: Will Investor Losses Lead to a Rising Tide for Pricing?

“A lot of these funds were deploying capital in risks that they did not understand or risks they were not aware they were writing—like the California wildfires,” said Mariza Costa, senior financial analyst, AM Best. “These investors were taken aback by the amount of capital that they lost.”

However, despite the pullback, observers expect capacity to return in 2020—provided rates continue to rise and a third straight year of extreme natural catastrophe losses does not unfold.

Insurers and reinsurers themselves certainly aren't abandoning the market. They are betting on ILS as well, with some acquiring third-party fund managers over the past few years or even launching their own ILS businesses.

They view ILS as a new revenue stream amid the prolonged low rate environment, earning potential profits by charging fees for underwriting and structuring risk.

“We've seen that everybody wants to have a piece of it,” Costa said. “Insurers see that it helps their own profitability, their relationships, their relevancy in the market. It lowers their cost of capital.

“It frees up their balance sheet because they're not writing it on their own—they're writing it through these vehicles. And it allows them to diversify and write risks that they otherwise would not be able to.”

AIG acquired Validus Holdings, which controls ILS asset manager AlphaCat, in 2018 for $5.6 billion.

Markel acquired CATCo Investment Management in 2015 and Nephila Holdings in August 2018. Scor Investment Partners acquired Coriolis Capital in May.

And earlier this year, Allianz subsidiary Pimco launched its own ILS business.

“We saw an opportunity to create a differentiated ILS platform in the market, with a value proposition based on direct access to distinctive risk, high quality underwriting and independence,” Pagnani said.

The “distinctive risk” he referred to is Allianz's global books of business, which are largely unavailable to the open market. Pimco can also source risk from third parties.

But it's hardly alone.

“ILS funds are a permanent fixture in our (re)insurance market,” Jean-Paul Conoscente, CEO of Scor Global P&C, said. “Their different capital basis makes them a good complement to traditional reinsurance in a number of segments. However, they do not have a fundamental impact on how reinsurers make money.”

Wind & Fire

ILS funds reported profitable years from 2012 to 2016, according to Eurekahedge ILS Advisers Index, which tracks the aggregate performance of the funds. They produced an aggregate cumulative return of nearly 80% from 2006 to 2018, corresponding to annualized aggregate returns of about 4.5%, according to the index.

AM Best, in conjunction with Guy Carpenter, estimates that third-party capital increased from $87 billion in 2017 to about $95 billion in 2018, while traditional reinsurance capital largely remained flat.

About $220 billion of notional exposure is traded each year in the catastrophe reinsurance market, according to Nephila.

Mariza Costa, AM Best

We’ve seen that everybody wants to have a piece of it. Insurers see that it helps their own profitability, their relationships, their relevancy in the market. It lowers their cost of capital. It frees up their balance sheet because they’re not writing it on their own—they’re writing it through these vehicles.

Mariza Costa
AM Best

“In the past few years, there's been a rush of investors to create these alternative capital funds,” Costa said.

But then came the nat cat events of the past two years.

Insured 2018 catastrophe losses amounted to more than $70 billion, according to AM Best. Nearly $200 billion in losses accumulated in the final six months of 2017 through 2018.

About 20% of the 2018 total third-party capital was trapped in the funds as of February, according to the Best's Market Segment Report.

As of June, assets under management remained trapped in collateral trusts to pay potential losses from 2017's Hurricane Irma, 2018's Hurricane Michael, the devastating Camp wildfire in California and Typhoon Jebi, whose estimated insured losses have risen from $5 billion initially to more than $15 billion.

“No investor wants their cash trapped that they're not making money on,” Costa said. “Some of it will be released, and some of it will be lost. Either way, they're not making money on it.”

The events hit in rapid succession, placing intense pressure on the claims settlement process and inflicting significant business interruption losses.

The Eurekahedge ILS Advisers Index saw annualized returns of -5.60% in 2017 and -3.58% in 2018, including consecutive monthly losses from September through December. November produced the worst performance ever (-3.68%).

“I think the hardening of the ILS market in 2019 had less to do with trapped capital than with a lack of return for several years in a row,” Conoscente said. “This pushed ILS managers to demand larger returns for their capital than in prior years.”

Meanwhile, the sell-off of catastrophe bonds exacerbated the losses. Fund managers were freeing up capital to renew other collateralized reinsurance deals.

Several trades “were precipitously executed below par, which impaired the ILS funds' returns at a time when both fund managers and investors were chasing better earnings,” according to the Best's Market Segment report.

For instance, investors in a $200 million cat bond issued in 2018 covering wildfire risk face a total loss. The issuer? Pacific Gas & Electric, the now-bankrupt Californian power supplier, which anticipates $30 billion in liabilities from wildfires blamed on its equipment.

ILS funds were able to replenish the majority of capital in 2018, even after some of it was trapped after the 2017 HIM hurricanes.

But after two straight years of losses, investors grew more selective when renewing 2019 investments.

“When these fund managers or carriers went back to them and asked to make the fund whole again without the trapped capital, many said no,” Costa said.

And pricing started to rise. January renewals saw some increases, but were deemed disappointing by many. Then the April renewals—mostly for Japanese earthquake—saw double-digit improvement. And the June renewals for Florida and some wildfire witnessed additional increases, especially for loss areas.

Meanwhile, ILS investors learned their lesson.

They held out for tighter terms and grew more cautious of certain risks, especially unpredictable and difficult to model nat cats such as wildfire.

“After all those events of the past two years, they're demanding better returns and higher pricing,” Costa said. “They're going to continue to invest. But now they're not going to embrace it with open arms or as open-ended as they did before.”

Alternative capital also shifted its focused to who was doing the underwriting.

“Going forward, the educated investor will stress the importance of high-resolution exposure management, underwriting and technical pricing of both modeled and nonmodeled risks, access to high quality books of global business and most importantly, transparency,” Pagnani said.

“The managers that can deliver this will be the winners of the reshuffling that is taking place with current investors, and will be well-positioned to secure the new capital that is currently on the sidelines,” he said.

Working Together

The alignment between third-party and traditional capital will endure, despite the recent volatility, analysts say.

Reinsurance investments constitute a minor portion in the portfolios of institutional investors and pension funds, so the past two years did not have major impact on their overall performance. And finding capital solutions with minimum correlation to capital markets is difficult.

It becomes even more important with downturns forecasted throughout the globe in 2020 and 2021.

Another result of the recent losses is the trend of alternative capital seeking rated paper from companies such as RenaissanceRe and Validus.

“It reinforced that rated carriers and rated paper aren't going anywhere,” Costa said. “There's always going to be a need in the market for them.”

Rick Pagnani, Pimco

Investors’ confidence in the market was clearly shaken over the course of the past two years. While the asset class still represents an attractive alternative investment, ILS investors have learned a hard lesson on the importance of manager selection.

Rick Pagnani

Alternative capital isn't going anywhere either. (Re)insurers and ILS managers have developed a symbiotic relationship.

Most traditional reinsurers view fund managers not as competitors, despite years of falling rates. They raise capital for the P/C industry and help diversify exposure in a world with increasing perils thanks to global warming and intensifying events.

“Rather than a threat, ILS should be viewed as a complementary tool in insurers' or reinsurers' tool kits in the quest to optimize capital, net profitability and consistent offerings to clients,” Scor's Conoscente said.

Pimco's Pagnani agrees. He views (re)insurers and ILS managers as allies more than competitors, joined by an “alignment of interests between the parties,” he said.

They sometimes rise to the level of partnerships.

An example of that collaboration is RenaissanceRe's Vermeer Reinsurance vehicle with a single investor, Dutch pension fund manager PGGM. It launched in December to write top-layer U.S. property cat risks. RenRe provides the underwriting. PGGM supplies the capital.

In typical ILS transactions there are 15 or so investors. The efficiency of this arrangement has piqued the interest of others in the space.

“It was something new: A particular company getting a particular investor big enough to fund it solely,” Costa said. “Companies are looking into this. You'll probably see more partnerships.”

But Albert Benchimol, president and chief executive officer of Axis Capital Holdings, told AMBestTV in June that insurance pricing will need to show sustainability before those investors regain confidence.

“There is a lot of capital still sitting in the sidelines, anxious to participate in our industry,” he said at the IIS Global Insurance Forum in Singapore. “However, as appropriate as it is to get diversification for those investors, they also need adequate returns.”

Pricing did rise between 10% and 20%—and as much as 35% on loss-affected accounts—in the January property cat retrocession renewals, according to AM Best.

Reinsurers need retro coverage to protect their books, and many ILS funds provide retro cover, according to Costa.

“They're really helping the traditional reinsurers get the pricing that they really need,” she said. “They're not working against each other. They're working together.

“The threat is eliminated if you combine the two. It's a different way to make money.”

Different Paths

Scor sought to grow its ILS platform.

Then it saw an opportunity in Coriolis Capital to increase scale and appeal to very large investors who prefer a bigger ILS manager.

“Coriolis Capital is one of the most established preeminent independent players in the ILS space,” said François de Varenne, CEO of Scor Investment Partners, “with one of the longest track records in the market.”

Scor has been a cat bond issuer through Scor Global P&C since 2000 and an asset manager through Scor Investment Partners since 2011.

Its ILS business amounted to more than $1.34 billion at the end of February. In March, Scor sponsored a four-year cat bond with a capacity of $250 million to protect itself against named storms in the United States, earthquakes in the U.S. and Canada, and windstorms in Europe.

“The broader reinsurance industry is experiencing a structural shift with the increased importance of alternative sources of capital,” de Varenne said.

Pimco launched its own platform earlier this year.

It had been evaluating a move into the ILS market for some time, Pagnani said. But first, it needed to build a foundation given the specialized nature of the asset class.

“Over the past several months we hand-selected a veteran ILS portfolio management team, and built out the technical systems, analytics and operational infrastructure,” he said.

It now includes four senior dedicated ILS specialists, leveraging support from across Pimco, including risk management, hedging and portfolio construction, tax, legal and compliance, and operations and finance support.

Besides its partnership with Allianz and Allianz Re, Pimco's ILS business also will reinsure third-party business.

Pagnani sees insurers continuing to acquire ILS businesses, or like Pimco, launch their own—“but not in large quantity,” he said.

Jeff Roberts is a senior associate editor. He can be reached at

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