Artex: US Property Market Challenges Drive Interest in Alternative Risk Solutions

Ongoing challenges in the US commercial property market continue to drive interest in alternative risk transfer solutions, according to Artex. In its Spring 2024 "State of the Market" report, The Alternative View, the creator and manager of insurance-linked and other structures that connect capital to risk anticipates the further formation of property captives.

"While capacity constraints in the property market have driven heightened interest in risk retention solutions, these are now a permanent tool in the tool chest, regardless of the market cycle," Artex says. "Even with rates starting to ease and capacity coming back into the US commercial property market, [we] anticipate that captive insurance will remain a long-term risk financing solution."

The company is seeing increased interest in group captive solutions in the middle-market space for more difficult risks driven by some tightening of casualty terms and conditions, and it expects this trend to continue.

Challenges experienced by many US and European property insurance buyers during 2023 have continued to drive demand for alternative risk transfer (ART) solutions, Artex says, including single-parent captives, cell captives, and group captive programs.

In the United States, a number of midsized corporate clients who had previously placed their insurance with a single insurer were faced with nonrenewal at January 1, 2024, as insurers reassessed their exposure to severe convective storms and other extreme weather perils. As a result, many were forced into the excess and surplus lines markets, and there was pressure on retail brokers to create new programs, often at short notice.

"Having had a year to ruminate on the challenges presented by a severely constrained property catastrophe market, insurance buyers have had time to explore the ART options available to them. As such, the demand for captive insurance remains high," Artex says.

"Clients want to remove the volatility and take more control," says Barry White, executive vice president, sales, analytics, and advisory, for Artex Risk Solutions, North America. "They see the long-term benefit of captives and how they can help manage risk. It's a strategic approach for all market conditions."

Even as capacity returns to the commercial market and pricing and terms begin to ease, Artex expects ART solutions to continue to feature more prominently as an essential part of companies' overall approach to risk financing.

In some of the more distressed classes of business, such as public sector institutions, agriculture, and transportation, captive and parametric solutions enable clients to secure coverage where it might not otherwise be available, Artex states. The company is also working in collaboration with brokers on the retail side of the business to provide more creative solutions, using captives within different layers of program towers to access broader terms and offer clients a wider range of renewal options.

European Captive Activity Increases

Among the trends for European clients that Artex has analyzed is the uptick in interest in establishing onshore captives. Jurisdictions including Italy, Spain, and the United Kingdom are moving to introduce new pro-captive legislation. They are following in the footsteps of France, which licensed 7 additional onshore captives last year (bringing the total number to 16), having introduced a new regulatory framework early in 2023.

In addition to new formations, Artex sees a continued move by existing parent companies to get greater use from their captives by putting new, diversifying classes of business, such as cyber and employee benefits, through their risk retention vehicles. In the case of emerging risks such as cyber, the captive can be used as an incubator to build up a clearer understanding of the parent company's risk profile over time.

Artex notes that demand is also picking up for more European domiciles to offer protective cell company (PCC) legislation as the popularity of cell captives continues to grow. While European legislators have not gone so far as to recognize captives as a distinct class of insurance under applicable regulation, the European supervisor has agreed to take a more proportional stance toward "small and non-complex undertakings," a new class agreed on by the Council of the EU and European Parliament in April 2024, which should encompass most European-domiciled captives.

Another trend of note, Artex reports, is the growth in interest in mutual insurance, where solutions are not readily available within the commercial insurance market. This follows the successful incorporation of a cyber-mutual in Belgium in 2022 by a group of European organizations. The global mutual and cooperative sector's share of the total insurance market rose to an 8-year high of 26.3 percent in 2022, according to data from industry body International Cooperative and Mutual Insurance Federation.

"In Europe, we're seeing more interest in the mutualization of risk, where smaller organizations come together to create buying power and share risk," said Michael Matthews, commercial director of Artex Risk Solutions, Europe, Middle East, and Africa.

Alternative Capital Markets

In the alternative capital markets, Artex reports that non-life alternative capital rose by $11 billion, or 11 percent, in 2023, supported by growth in catastrophe bonds, which contributed approximately $6 billion of the increase.

The key drivers of last year's robust performance were retained earnings resulting from reduced loss activity and higher collateral yields, net inflows, and mark-to-market gains, Artex says, adding, "while we have yet to see a significant major influx of new capital, we anticipate further improvement in pricing from a cedant perspective."

Collateralized reinsurance continued to reduce on a relative share basis during 2023, in line with developments seen in 2022, the company reports.

"[We] anticipate a promising shift in the reinsurance and insurance-linked securities (ILS) markets, characterized by a return to stability," Artex states. "The landscape is primed for a smoother reinsurance renewal cycle, with capacity coming back into the space. This signifies a renewed confidence among reinsurers and investors alike, and as the industry recalibrates, stakeholders can anticipate a more structured and balanced marketplace."

ILS Interest Turns Up

Investors continue to be attracted to the market due to its strong fundamentals. As a diversifying asset class, ILS and collateralized reinsurance offer liquidity and robust risk-adjusted returns. After a strong performance in 2023, Artex is witnessing a small uptick in interest from investors, including hedge funds and pension funds.

Established long-term ILS investors continue to actively engage with the sector, drawn by its stability and potential for strong returns. Concurrently, Artex says, "we are seeing some newer capital entering the market, which may be signaling a growing recognition of attractiveness across different investment strategies."

Asset managers and hedge funds that may have previously invested in catastrophe (cat) bonds as their first diversifying asset class may now be interested in private collateralized reinsurance, according to Scott Cobon, managing director, insurance management services, Artex Capital Solutions.

"Risk-adjusted returns are significantly up over the last 24 months and that has driven some nimble capacity into the ILS market, both in the form of collateralized reinsurance and cat bonds," said Kathleen Faries, CEO of Artex Capital Solutions.

Catastrophe Bonds and ILWs

From a catastrophe bond perspective, the first quarter of 2024 was marked by robust issuance figures. For only the second time in the ILS market's history, quarterly issuance for the first quarter of 2024 exceeded $4 billion. At $4.23 billion, issuance was 30 percent higher than Q1 2023 and is above the 10-year average for the period by roughly $1.1 billion.

Although concerns surrounding trapped collateral and loss creep have been a feature in recent years, Artex says, investors are ready to move on. "Looking ahead, there is robust appetite for cat bond issuances focused on peak perils. As investors recalibrate their strategies, they are drawn to opportunities that offer exposure to high-value perils, recognizing the potential for attractive risk-adjusted returns in these specialized segments of the market," says the company.

Despite the increased frequency and severity of secondary perils, their impact on the ILS market has been minimal, with only a muted effect on collateralized reinsurance, demonstrating its resilience in the face of an evolving risk landscape. "This is due to the bulk of losses being absorbed within the lower layers of catastrophe programs, as risk has been successfully redistributed between primary and secondary markets within the property catastrophe space," Artex reports.

The company continues as follows: "A shift in attachment points and change in terms and conditions could indicate a change in market dynamics, paving the way for softer conditions. Such adjustments often reflect evolving risk perceptions, regulatory changes, or shifts in investor preferences, all of which can influence pricing and overall market conditions.

"As and when attachment points start to shift, reinsurers and investors may need to reassess their risk appetite and strategies to adapt to evolving market dynamics. While we have not yet seen a significant influx of new capital, other than into some of the best-performing ILS funds, we would anticipate further improvement in pricing and terms from a cedant perspective as the year unfolds."

Current forecasts for the Atlantic hurricane season indicate above-average activity is likely, intensifying cedants' focus on risk mitigation solutions within the ILS market. "Given the anticipation of a potentially active season, hedging practices are gaining importance as a proactive measure to manage exposure to potential losses," Artex reports. "We are seeing a lot of interest in industry loss warranties (ILWs)."

The outcome of the season will inevitably influence pricing trends and investor behavior, if the market is tested by a major loss and, in particular, if elements of that loss are either unexpected or unmodeled.

Finally, Artex reports, the impact of Moody's RMS version 23 is expected to negatively affect modeling output, especially for named windstorms in the Gulf Coast and Floridian regions. Anticipation of the new model release is already causing a tightening of cat bond spreads but it has not yet been widely adopted, and Artex said it expects to see more impact later in the year.