COVID drove higher ILW demand. Positive trends expected for 2021: City National Rochdale

Demand for reinsurance and retrocessional protection in the form of industry loss warranties (ILW’s) increased due to the COVID-19 pandemic and favourable market conditions are expected to persist, with a chance of higher demand again towards the end of this year, City National Rochdale has explained.

Reporting on its industry loss warranty (ILW) focused mutual insurance-linked securities (ILS) investment fund, investment manager City National Rochdale said that it sees a dynamic set of opportunities going forwards.

The City National Rochdale Select Strategies (CNRLX) is a mutual investment fund structured in the interval style, with a focus on investments in industry loss warranty (ILW) focused reinsurance and retrocession contracts across global peak peril zones as well as some regional U.S. ILW contracts, plus some investments into catastrophe bonds.

The fund accesses the ILW market and sources its risk via a relationship with asset manager Neuberger Berman’s experienced ILW and index reinsurance investment team, with the assets of this fund deployed into cells of the Neuberger Berman ILS team’s NB Re Ltd. vehicle (previously named Iris Re).

The ILW focused investment fund reported total net assets at January 31st 2020 of almost $123.2 million.

By July 31st 2020 this had increased to just over $131 million.

Total investments, into segregated cells of the NB Re reinsurance vehicle containing ILW contracts and some catastrophe bonds, invested in by the fund were valued at $107.4 million at January 31st, and that has also risen to $119.25 million at July 31st 2020.

The investment manager notes that conditions in the insurance-linked securities (ILS) market in general are improving and that demand and pricing for ILW protection has been on the rise.

“Overall, the impact of COVID-19 stressed the supply side of a market whose capacity had already been deeply affected by the numerous natural catastrophes of 2017, 2018, and 2019,” the investment manager explained.

Adding that, “The demand side of the market was further exacerbated by the broader financial market volatility and uncertainty.

“These factors led insurers and reinsurers to seek more protection at a time of very little supply, which resulted in considerable rate increases for both industry loss warranties (“ILWs”) and primary catastrophe bond issuance.”

While the fund only delivered a 0.64% return for the six months ended July 31st 2020, the manager noted that most of its returns are earned through the hurricane season, given the more targeted and ILW focused approach.

With the 2020 hurricane season seeing record levels of activity, the manager also noted it has taken a slightly more defensive approach with portfolio construction this year.

Through July 31st no catastrophe events had impacted the fund and it’s unlikely any of the recent hurricanes will have either, given losses have not really hit levels where the majority of ILW exposure sits in reinsurance and retro towers.

City National Rochdale notes the potential for the fund to capitalise on market conditions going forwards.

“Current market events have created a dynamic set of opportunities for the Fund. Insurance-Linked Securities (“ILSs”) market conditions continue to be very favorable from both a pricing and demand standpoint. Pricing in the ILW market continues to improve, with increasing demand from a wide range of counterparty types given the limited supply of third-party capital in the market,” the manager explained.

The investment adviser went on to explain that the second quarter of 2020 was a particularly strong period for the ILW market, with the COVID-19 pandemic a factor as it drove disruption across markets but also heightened risk awareness and aversion among reinsurance buyers.

“While the long-term impacts of COVID-19 on ILS are yet to be fully quantified, there has been further outflow of capital from the space with investors seeking liquidity at the start of the second quarter. While the second quarter tends to be relatively quiet, this year we observed one of the busiest periods of trading and underwriting since the inception of the Fund. The market dynamics and uncertainty from COVID-19 pushed many reinsurers and ILS managers towards buying more ILWs than in previous years,” they explained.

The City National Rochdale fund was well-positioned to capitalise on this, and it “reviewed hundreds of opportunities, underwrote more than twice the limit exposure in the same period in 2019, and dictated our preferred structural considerations, terms, and conditions.”

Looking ahead, the manager expects more dynamic opportunities towards the year-end reinsurance renewals.

It expects, “The demand for 2021 protection to come very early in the fourth quarter as protection buyers will be eager to lock in protection before the frenzy of the January renewal cycle. The potential losses and collateral trapping from COVID-19, coupled with a difficult fundraising environment for existing ILS participants, may lead to further price hardening and increased demand, similar to what we observed in the second quarter of 2020.”