A significant percentage of deal activity in the life ILS market consists of ‘value in force’ (VIF) transactions; the life ILS fund lends money to life insurance companies, with the collateral being the premium payments of a block of policies.
One impact of the higher interest rate environment on both sides of the Atlantic is that deal activity in the VIF space is, currently, subdued when compared to previous years when lower interest rate regimes were more normal. The reason is clear; higher risk-free rates trickle down into the alternative financing market.
“Counterparties have much higher costs of financing now. If they have 15 years’ worth of cash flows, and the market securitises at risk free + 700 basis points, it’s more expensive for them to do that now than, say, two years ago,” said Adam Robinson, Head of Life and Chief Underwriting Officer at Securis Investment Partners.
The loans made by life ILS funds tend to be multi-year in nature, like many in the broader private debt market. But for those insurance companies looking for shorter term financing options, accessing capital is not a great deal easier.
“A lot of counterparties have been looking for shorter term revolving facilities, however with the inversion of the yield curve, these have become more expensive for them as well,” added Robinson.
Accessing the debt markets is harder now for all businesses, public or private. In the general private debt market, banks are pulling back, as are various alternative credit providers; even the private equity sponsor-backed space is seeing a slowdown. But one of the idiosyncrasies of the life ILS space is that insurance counterparties seeking financing solutions don’t have many other places to turn.
“Banks are typically not in the space. Private credit funds could potentially enter the life ILS market, but they largely wouldn’t be able to absorb actuarial risks. The Life ILS market absorbs lapse and mortality risk into the structure of the deals done in the space. If lapse rates and mortality rates increase, the life ILS vehicle suffers in the sense that returns are lower, but life ILS doesn’t typically go after the balance sheet of the counterparty, so the market provides an obvious risk bearing structure for insurance companies,” said Robinson.
Roadblocks to deal activity aren’t limited purely to the cost of capital for the life ILS counterparty. Changes in mortality data are making modelling mortality risk more difficult. And understanding the true rate of lapsed policies in the market is similarly difficult.
“Higher inflation, like you see in the UK, is impacting the life ILS space. Consumers will no longer pay for some products that they don’t consider necessities, and so some insurance products will be impacted here,” said Robinson. “And during Covid, some insurers offered premium repayment holidays, so technically, the policies didn’t lapse. But are these policies really still active or are they going to lapse when the holiday ends? All of these considerations are affecting the pricing of risk in the space.”
Time will tell whether the current, elevated – at least, elevated when compared to the post-Global Financial Crisis period – interest rate regime persists in the medium term. But the supply of deals in the life ILS space isn’t purely a function of the prevailing macroeconomic environment.
Historically, deals in the life ILS market have been conducted bilaterally between parties, meaning that connections and networks have had a significant impact on a portfolio manager’s ability to source and complete transactions. But now, brokers are moving into the space, which could increase the supply of risk if they can work with the insurers and reinsurers to bring more products to market. Additionally, the market in Asia is largely untapped, with the vast majority of life ILS activity coming in the US, Canada, and Western and Northern Europe.
Additionally, other trades in the market are picking up steam.
“Appetite from insurers with regards to protection is starting to pick up,” said Robinson. “A number of them are starting to engage in conversations around this, because an advantage of life ILS when compared to a reinsurer is that they’re not a competitor, so there’s little to no intellectual property risk for an insurance company when showing a block of business to a life ILS fund.”
An irony of the life ILS market, which is the same in all private credit markets, is that investors are pausing or reducing their allocations to the space, given the relative attractiveness of more liquid debt markets that are now, for the first time in a long time, providing a respectable yield (albeit still a negative real yield, when factoring in inflation). But despite the pull back in life ILS activity, the deals that are getting done are charging a higher interest rate, which means higher returns than before, a boon to those investors that have allocations in the space.
Activity in the life ILS space is set to be mixed in the foreseeable future; at least, in the VIF space, as the insurers wait for interest rates to start coming down. But when compared to the broader private credit market, the moat around the space should insulate it from too much of a pullback in the short term.
“As I mentioned, life ILS counterparties have fewer places to turn than other companies for their financing needs. Activity is lower, but only marginally so, and so the outlook for activity remains solid,” said Robinson.