With the catastrophe bond and insurance-linked securities (ILS) market expected to continue growing by analysts at investment bank Jefferies, they say that this will necessitate a continued expansion further into new and secondary perils, to offer broader risk management for re/insurers and an increasingly diversified investment choice for allocators.
In a recent report, the Jefferies equity analyst team focused on the insurance and reinsurance industry, explained their belief that the cat bond and ILS market has a “meaningful growth opportunity” ahead of it, with a near doubling of sector capital to as much as $200 billion possible by the year 2032.They also highlighted that the rebound in issuance and expansion of the catastrophe bond market of the last few years is expected to broaden out to other ILS vehicles in 2025, such as collateralized reinsurance and sidecar opportunities.
The analysts also discussed the fact that ILS opportunities are expected to expand as well, both for those seeking risk management and protection, and for the investor community that leverages ILS investments as an alternative and diversifying asset class.
The cat bond and ILS asset class is still nascent, in the Jefferies analysts opinion, which means, “The complexity and nascency of the market may keep some investors away.”
But continued innovation and development in the risk modelling community is expected to unlock increasing investor confidence, as well as a growing suite of investment options.
“Continued third party modeling improvements and a growing capacity need in lines and risks such as cyber and flood should present long term growth opportunities,” the analysts said.
On these opportunities, the analysts explained why they are candidates for an increasingly advanced ILS market backed up be increasingly sophisticated risk models.
“We previously sized the potential cyber market in the hundreds of billion of annual global premiums by 2040, compared to ~$15bn today; we do not believe that the traditional (re)insurance market has the capacity and appetite for that, which may mean that a more robust ILS alternative is necessary – with the fist cyber bond issued last year.
“With regards to US flood – that risk is typically directly or indirectly insured by the government, and legislatures have, from time to time, floated the idea of transferring the risk to the private market. The National Flood Insurance Program (NFIP) writes ~$4bn of heavily subsidized flood premiums annually, compared to ~$800mn of private market NPW,” the analysts said.
But the Jefferies team also see opportunities for much more ILS participation in other catastrophe perils and regions as well.
The analysts say, “It would also appear to us as if the European ILS market is under-sized relative to its growing weather risk profile, and we expect developing Asian and Latam economies to necessitate a larger and more sophisticated market that should (reflecting greater insurable values and growing insurance penetration) grow over time and offer more ILS opportunities.”
Adding that, “In addition, we expect modeling of secondary perils to improve as they grow in frequency and severity, which would create further opportunities for the ILS market to grow.”
These opportunities for ILS market growth and expansion, that will be fuelled by advancements in risk models and analytics, as well as more abundant data and better capabilities to process it, will not just drive new investment opportunities for the ILS market.
They will also increase the range of use-cases that insurance and reinsurance firms can transact with ILS markets on.
The Jefferies analyst team said, “For insurers, a larger ILS market offers broader risk management opportunities, and at a relatively attractive cost base considering that ILS cost of capital tends to be lower than that of traditional reinsurers. For investors, ILS continues to offer a non market correlated investment opportunity with high yields. While this narrative was hurt in 2016-2022 due to repeated large CAT losses, we continue to believe that the value to investors of ILS will be measured over a longer period of time. Moreover, some of the low returns experienced in recent years can be and have been addressed through the structural market changes we laid out earlier.”
Securing expansion and growth into these areas won’t be without its challenges though.
The Jefferies team highlight, “Non-modeled losses such as social inflation and fraud have also presented challenges that could be reduced or eliminated through legislative changes and/or through tighter language contracts,” as well as, “Finding other risk classes with little to no correlation to other asset classes and a relatively short tail,” as areas for future and further ILS market focus.
Also read: ILS market has “meaningful growth opportunity” to $200bn by 2032: Jefferies.
