Insurance-related securities (ILS) such as catastrophe bonds and other forms of alternative capital will play a growing role in Latin American reinsurance markets, Fitch Ratings predicts, as long as limitations around data and risk modeling can be overcome.
In a recent report, Fitch highlighted why reinsurance underwriting in Latin America might be attractive, given the opportunities for diversification, the relatively untapped market, growing economies and improving fundamentals.
Nevertheless, the ILS markets remain very small players in Latin American reinsurance programs in general, with a small participation guaranteed in some program layers.
Meanwhile, the catastrophe bond market has so far been confined to World Bank-facilitated sovereign bond issues focused on cutting-edge catastrophe risks from Mexico and a number of other countries.
Apart from this, a handful of private ILS deals have been made, such as the innovative AlphaTerra Validus deals, which provide retrocession reinsurance protection to Terra Brasis Re and are supported by the dedicated ILS unit of AIG AlphaCat Managers.
But the ILS markets are not growing as one would expect in this region, despite the high levels of exposure to natural disasters.
One of the main reasons for this is competition from the traditional reinsurance market, as in Latin America the major global reinsurers have dominant market share in many countries.
Also, insurance penetration remains very low, in some countries below Asia-Pacific and Latin America, you don’t have a country like Japan, which has been much faster to adopt the bonds of cat bond and ILS protection than the rest of Asia due to its higher insured. values and coverage penetration.
This means that Latin America is a great area of potential opportunity for the ILS market and which could benefit the local insurance industry, by providing effective funding from the region’s catastrophe risk capital market.
But Fitch highlights the main issue that still hinders the expansion of the ILS market in Latin America, the quality of the data and the lack of robust models for certain perils and countries.
Fitch explained, “Part of the reason is that the accurate entry of insurance data is fundamental to ensuring adequate protection against disasters. This limitation places partial constraints on the use of alternative capital. Thus, modeling capabilities need to be improved and more comprehensive statistics still need to be compiled for alternative sources of capital to be more widely used.
“Alternative capital will have an increasing role to play in the evolution of reinsurance and insurance markets in Latin America, as some of the current limitations improve over time. “
One area where the expansion of the ILS market could occur more quickly in Latin America is Brazil, which, as we explained earlier, now has its own set of formalized ILS rules and regulations.
“With this new regulation, Brazil is now able to issue domestic ILS from its re / insurance market, as a possible new alternative to foster its growing re / insurance industry,” said Fitch.
However, this initiative has yet to see its first broadcasts.
Fitch said, “However, there are currently no new ILS transactions in the Brazilian market. As ILS instruments expand further and allow reinsurers to access capital at lower cost, both locally and abroad, to meet their reinsurance needs, ultimately the goal is that the cost savings can reach the entire sector and be passed on to the insurance consumer ”