Expansion of the insurance-linked securities (ILS) and catastrophe bond market beyond the traditional property catastrophe exposures holds both "promise & peril" for market participants, according to brokerage Willis Towers Watson (NASDAQ:WLTW).
The Willis Towers Watson Securities division of the broker, that structures and arranges cat bond and ILS transactions, discussed the potential for ILS market expansion more deeply into both insurance and reinsurance risks in its latest quarterly report.
The firm notes that "The ILS market is roaring forward through the first half of 2018" and as its asset base increases along with transaction volumes, the need for ongoing expansion of the ILS asset class is clear.
Driving market growth and ultimately expansion are the usual drivers.
The fact is that insurance and reinsurance firms are increasingly attracted by the cost and efficiency of cat bond and ILS risk transfer.
While on the investor side, the attraction to the portfolio diversification benefits of ILS continues, and WTW says that end investors want to increase their allocations, with natural catastrophe reinsurance-linked investments still their main target.
But to accommodate all of the capital interest that is seen in ILS, the market will have to continue to innovate and expand as well, driving the market towards new classes of risk and perils.
WTW says that it continues to see innovation in terms of the ILS structure, as well as "an effort to offer more risks and ILS structures reflecting the diversity in investors and in risk transfer needs."
Expansion beyond natural catastrophe risk is one of the trends highlighted, but here WTW warns that, "This is a trend with promise and peril."
"It can help make a wide range of insurance more available and affordable and help cover the protection gap. On the other hand, nat cat risk still has some advantages in modeling and diversification," the company explains.
While access to new risks is attractive, it needs to be done carefully and with the understanding of how it will impact the overall ILS portfolio's diversification and correlation with wider markets and economic factors.
Jumping into other classes of risk without careful consideration of the impacts to the investor proposition of ILS is unwise and could result in transactions either not getting the backing they could have, or investors becoming less attracted to the asset class if the benefits of portfolio diversification become diluted.
Positively though, WTW feels the market is approaching its expansion opportunities in a sensible manner.
Saying, "The good news is that the expansion so far is mindful of and has addressed these differences vis-à-vis nat cat in various ways. If successful, an ILS market much larger than would be possible on nat cat alone seems likely."
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