Asian ILS market to thrive as investors seek diversification

September 19 2022 by

Asia Pacific is expected to see robust growth in ILS issuances as it offers an attractive diversification opportunity to financial investors and with Hong Kong and Singapore competing to build ILS markets in the respective cities with grants and other regulatory support.

“Bonds and equities used to be negatively correlated but recently that both moved in the same direction, thus stripping investors of the benefit of diversification,” said Clarence Wong, chief economist of Hong Kong-based Peak Re.

And ILS offers an opportunity for investors seeking other trades to safeguard their returns.

The Financial Times noted late last month that, an investor sticking with a “sweet spot” portfolio of 60% global equities and 40% government bonds would have lost a 20% in the first half the year.

Bernhard Kotanko, senior partner at McKinsey, said: “I think the main benefit of ILS is one of diversification rather than the absolute level of return. The main reason to invest in ILS is actually for diversification and a reduction of interest rate sensitivity.”

According to the Aon ILS annual report for 2022, in the 12-month period ending June 30, 2022, four Asian-based sponsors came to market, which introduced new structures including a new domicile, untested weather models and reporting mechanisms. The four issuances raised a combined US$1.175 billion. While the region also saw two redemptions totaling US$1.02 billion.

The redemption and new issuances covering Asia perils seen in the past year still suggest a healthy investor appetite for Asia catastrophe bonds, the report said.

 “With high-interest rates and an inflationary outlook, there may be a short-term dislocation in the market as treasury yields are rising, however, in the long term, ILS will offer better yields and be attractive to investors.”

Clarence Wong, Peak Re

 

Busy pipeline
While the current inflationary pressure, broader macroeconomic fluctuations and the conflict in Ukraine have resulted in the ILS market experiencing a level of rate hardening, the pipeline for cat bonds, in particular, remains robust and with investors now able to enjoy higher margins, capital inflows are certainly possible throughout the remainder of the year, Aon said in its report.

“There are now a couple of transactions in Hong Kong as well as the ones in Singapore,” said William Ho CEO of MS Amlin for Asia Pacific.

“At this time of development, seeing these transactions can only be a positive for the region and the more awareness this can generate, the better the chance to see this region continue to develop and harbour further ILS transactions in the future,” he added.

“With high-interest rates and an inflationary outlook, there may be a short-term dislocation in the market as treasury yields are rising, however, in the long term, ILS will offer better yields and be attractive to investors,” said Wong.

While higher coupons would mean an increase in the cost of capital for issuers, the relative cost will remain unchanged because premiums are also rising to adjust for the higher claims costs.

McKinsey’s Kotanko said, “Of course, ILS had a bit of a spread on top of the risk-free rate. But I think that’s that is manageable.”

While there is an opportunity in Asia with both Singapore and Hong Kong competing to build ILS markets in their respective cities with grants and other regulatory support.

In Hong Kong, the Aon report noted that after the passing of the Insurance (Amendment) Bill in June 2022, sponsors have started utilising the regime and with the continuation of the two-year pilot ILS grant scheme currently in effect in the jurisdiction, growth prospects for the region and the Asian market more broadly look to be positive for the year ahead.

The grant scheme continues to be an attractive incentive for potential sponsors to use Hong Kong as a domicile and investors have also gradually gained comfort and confidence in the jurisdictions now that initial transactions have been proven to be a success.

Franz Josef Hahn, chief executive of Peak Re, which launched a US$150 million 144A catastrophe bond via its special purpose vehicle in Hong Kong in June this year, told InsuranceAsia News, “We find the HK SPI (Special Purpose Insurer) application process transparent and straightforward, and the HK Insurance Authority team is highly professional and pragmatic in their approach.”

“[W]e will do it again for sure, if and when we find the right risk, ready to be put into an ILS,” Hahn added.

Meanwhile, in Singapore, the Monetary Authority of Singapore (MAS) has in the past year made proposals to grant special purpose reinsurance vehicles exemption from insurance regulatory requirements pertaining to investments policies and there is a proposal to exclude these vehicles from full public disclosure which are typically required of an insurance or reinsurance business domiciled in Singapore.

These initiatives are received positively by sponsors and investors as evidenced in the Catahoula II Re transaction becoming the first cat bond listed on the SGX in June 2022, the Aon report said.

Despite the growing optimism in the region, Wong said, “There is a need for investor education to ensure investors are comfortable with this sort of risk and convince them of the diversification benefit.”


Long-term evolution
Henning Ludolphs, Hannover Re’s managing director for retrocession and capital markets, said last week that there’s not much risk coming from Asia to the capital markets, with the exception of Japan.  “Although, there is a fair amount of capital coming from Asia in the ILS market – so there is money coming from the region from the investment perspective. Going forward, I believe that the ILS market will grow overall, including Asia”.

While the market in the region is growing and there is more awareness, Asian ILS offerings are still quite natural catastrophe focused and there isn’t much diversity.

“The Asian ILS market, for now, will largely see Asian issuers and the offerings from the region will largely be for traditional nat cat risks such earthquakes or storms and such other perils,” said Wong.

“Asian markets are yet unlikely to offer other products such as mortality bonds or longevity bonds or packaging of motor risks in the near term. The lack of models and data is a challenge that hampers the securitisation of a variety of risks from the region.”

At the heart is the lack of loss reporting data in APAC. However, the Aon report noted that with more service providers such as RMS, Property Claims Services and Perils, expanding their Asia offerings will allow for a range of applications including industry loss-based risk transfer products such as industry loss warranty contracts and insurance-linked securities.

Kotanko said, “On the positive side the underlying risks are growing fast. And the awareness of these underlying risks is increasing. So, I think we'll see how these things play out with greater awareness and greater underlying risk. I would assume ILS will continue to evolve and grow. Maybe short term, it's a little bit of flat to curve than expected [because of the interest rate hike.”

Ho of MS Amlin said, “We expect the conditions to continue to be challenging but we hope the momentum continues into 2023 seeing more transactions that are Asian-based. As the report mentioned.”

Bernhard Kotanko
“On the positive side the underlying risks are growing fast. And the awareness of these underlying risks is increasing."

Bernhard Kotanko, McKinsey

 

All these enabling factors coupled with a hard retrocession market in Asia Pacific since January renewals, reinsurer appetite primarily around lower programmes have seen some constraints, which resulted in significant restructuring and re-focus of portfolios by some markets.

Australia and New Zealand, for example, is now key markets for catastrophe risk at the forefront of climate change, the fourth largest for catastrophe reinsurance demand globally, just behind Japan.


Reinsurers sought significant rate increases at the Australian June and July renewals and many were not willing to attach to lower catastrophe layers, at any price, according to the Aon report. The market pushed for higher retentions as reinsurers sought to move to cover tail risk rather than be over-exposed to a frequency of catastrophe events.

The use of alternative markets slightly increased year over year as several capital providers took advantage of a “dislocated” lower layer market to seek attractive structures and returns

Moreover, the exit of some players in Asia from the property treaty markets and the reduction of capacity in these lower layers by larger reinsurers will force some to see alternative markets such as ILS to meet the capacity shortfall.

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