ILS managers will leverage strong performance in the Covid-19 crisis to grow assets in the years to come, Aon Securities said in its annual ILS market review.
The broker joined peers in forecasting continued investor demand for liquid cat bonds, while it noted that the sidecar and collateralised reinsurance segments have contributed the bulk of the decline in capital levels over the past year.
The cat bond sector has also shrunk 1.5% to $28.8bn, but Aon said there is interest from a broader range of sponsors including governments and corporates, and with investors giving preference to liquidity in the post-Covid-19 markets.
"Capital inflows will depend on broader financial systems, but with equity and debt markets pricing close to pre-crisis levels in some cases and with a prolonged low-interest-rate environment, the demonstrated value of the ILS markets will drive capital to this market," Aon explained.
The Aon All-Bond index made an 8.4% return in the 12 months to 30 June 2020, with one cat loss impact from the Peruvian earthquake last year.
The ILS index trailed the S&P 500 index gain of 5.39% over the same period, but came in well ahead of the 1.48% gain on a comparable 3-5 year BB US High Yield index.
The ILS index has delivered a 5.24% annualised return over the past five years, versus 6.06% on the BB High Yield index.
Investor base
The market share of investors participating in cat bond deals remained largely stable year on year, with ILS funds leading on 74%, and institutional investors lifting their share from 9% to 11%.
Multi-strategy funds dropped back their participation from 7% to 4%, which the broker attributed to a drop in average spreads in 2020 as some multi-strat investors prefer higher-yielding deals.
Most investors come from the US, with a 46% share, but French investor participation nearly doubled from 4% to 7% as Bermuda dropped back from 16% to 12%.
Rate increases have brought back some investors from a range of jurisdictions such as Sweden, Canada, Germany and Japan, Aon added.
Shift to cat bonds
Within the $91bn ILS market, the collateralised reinsurance market is expected to continue to contract.
Aon put this segment at $49.3bn, down from $52.7bn at the end of 2019. As this segment typically picks up more lower-level catastrophe losses than cat bonds, investor appetite for collateralised reinsurance can be more sensitive to loss activity, Aon noted.
However, ILS managers continue to deploy in this segment via use of fronting providers.
The sidecar market has shrunk by 17% from $8.2bn in Q1 2019 to $6.8bn in Q1 2020, impacted by investor withdrawals. Sponsor demand for cover currently materially outweighs supply, Aon reiterated.
Veteran sidecar sponsors succeeded with repeat issues, but "some were required to compromise on terms to achieve scale", the broker added.
Some vehicles could take Covid-19 losses this year, although reserving will be subject to change, it noted.
Meanwhile, investors are increasingly looking to sidecars for non-peak perils.
As well as cat bonds, the ILW market has also been favoured with an additional $250mn of capacity traded in the first half of the year as rates rose, as more players showed they were willing to write small ILW books alongside specialists in the field.
Private placement bonds are also likely to grow, as they open up the ILS market to a wider range of cedants, the broker explained.
Its recent Randolph Re transaction was a syndicated wildfire deal, raising around $50mn of cover – which is below the efficient size for a traditional cat bond.
The firm estimated that a significant shift in private placements towards greater use of syndicated deals has occurred in the past two years – making up 40-50% of private bond placements.
These cedant-driven deals compare to private cat bond lite transactions that are driven by a single investor converting collateralised re into note format.