January rate increases push ILS projected returns up strongly into teens
After a strong round of rate increases at the 1 January renewals, expected ILS returns for 2023 are firmly into the teens for many strategies – up several points year-on-year, and well ahead of soft market benchmarks.
With a stronger headwind from higher collateral yields, this means some mid-high-risk strategies are now projected to make close to 20% returns for the year, assuming cat loss activity falls within modelled expectations.
In-built leverage amplifies the effect of rising rates when it comes to projected ILS returns, as higher premiums allow investors to back more reinsurance limit relative to their capital contribution.
Generally, ILS expected returns for 2023 have risen in the range of 25%-50% depending on the risk level, with lower return funds benefitting proportionately more, sources said.
The consensus on projected returns for lower risk funds was mid- to high single digits, excluding floating rate collateral yield.
Expectations varied more widely for mid-risk funds, perhaps indicating differences in what may be described as a mid-risk fund: projections ranged from the high single digits to mid-teens.
For mid-high-risk funds, the expected returns began in the mid-teens up to the low 20s.
These figures are up several points from last year and more substantially from prior soft market single-digit yields.
Cat bond funds are also set to make double-digit returns when including collateral yield. Analyst Lane Financial last month pegged 2023 expected underwriting cat bond returns at 7.3%, with the loss-free return at 9.82%, excluding collateral yields.
Sentiment about rate rises is universally upbeat, with the step up achieved by ILS managers at 1 January described as a “significant improvement” and “important rate increases”.
However, in general, the performance of the ILS market over the past five to 10 years was thought likely to keep a dampener on investor enthusiasm through 2023, even despite the headline rate increases.
Funds’ experience on rate increases in January hovered around 50%, risk-adjusted, for remote risk/ US wind, inching to 60% in some cases. Europe/international and non-peak risk achieved uplifts more in the 20%-30% range. Retro rate increases were in the ballpark of 40%.
There is also a clear sense that structural improvements have helped to shore up returns by doing more to filter out attritional losses, to minimise worst-case losses, and to shift the economics on transactions in investors’ favour, such as with higher redemption spreads.
The gains build on changes already made since 2017 – which helped the ILS Advisers index loss for 2022 come in 60% lower than the 2017 downturn, despite the impact of major Hurricane Ian.
One manager noted that the market is now effectively pricing for “an Ian every year”, and that strategies that came close to breakeven last year would be on track to profit even with a major hurricane loss.
Floating rate boost
One somewhat contentious subject is whether it’s appropriate to incorporate collateral returns in the overall expected return number.
Sources on one hand argue that including the floating rate makes it less clear what’s happening with the investment in insurance risk, while others say the current upside is a genuine positive feature of a floating rate instrument.
The past year has brought a major uplift in short-term Treasuries, now yielding above 4%.
1 June impact on returns
Sources noted that the rate increases achieved at the upcoming mid-year renewal for southeast US hurricane risk would also form an important component of the returns picture for the year overall.
Managers expect the harder rate environment to hold strong throughout 2023. Several are looking ahead to the 1 June renewal as the moment when true dislocation could occur in the market.
The final stages of the January renewal became smoother when US buyers opted against placing new coverage, as we have previously reported, but the 1 June Florida renewal is seen as different in that thinly capitalised domestic carriers do not have the flexibility not to buy.
The outcome of 1 June in terms of influencing returns also turns on how much new capital comes in.
Sources noted the not wholly smooth-running placement of several cat bonds so far in Q1 as a signposting of greater potential dislocation at the Florida renewal.
"I have been pleasantly surprised by the ability of the bond market to remain disrupted – cash hasn’t flown back in,” one investor-side source said.