With global warming said likely to drive a rise in the frequency and severity of natural disasters and certain extreme weather events, the re/insurance industry faces a shifting landscape.However, a recent analysis by Solidum Partners AG suggests that the insurance-linked securities (ILS) market is uniquely positioned as a key capital source to support re/insurers.In a recent report, the Swiss specialist ILS investment manager explained that while it believes the ILS market is likely to ultimately profit more than the traditional reinsurance industry from the effects of global warming, given the likely growing need for capacity, it will need to adapt fast in order to handle the new volatility and complexity of climate risk.According to the firm, several factors are driving this trend, while another is due to the solvency rules that exist within the reinsurance sector.

“Traditional reinsurers must maintain strict solvency margins and comply with Solvency II (in the EU) or similar regimes globally.Covering a 1-in-250-year event requires them to hold large capital buffers, which ties up capital and lowers returns on equity.In addition, they face asset pressure due to climate exposure in their own investment portfolios (e.g.

real estate, fossil fuels, etc.).As a consequence, re-insurers’ capacities to digest these additional volumes, even though economically attractive, are limited,” Solidum’s analysts said.In contrast, the firm’s report emphasises that ILS instruments are event-specific and finite in duration, with capital fully collateralized upfront.

“This structure shields ILS sponsors from post-event balance sheet deterioration and allows investors to take more concentrated risk with capped downside,” Solidum explains.Solidum expects that as insurance premiums rise, spreads within the ILS market will receive an equally strong boost.Analysts further noted that the growing “protection gap” will funnel increasing volumes toward the ILS market; as the supply of risk grows to meet investor demand, spreads will likely see additional tailwinds.

“Because climate change increases frequency and severity of events, greater long-term reliance on external capital will most likely be the reality.Reinsurers are increasingly offloading tail risk to ILS markets, boosting ILS relevance and return potential,” the report reads.While these developments are expected to have a significant positive effect on future spreads, Solidum cautions that ILS managers still face critical hurdles.

Specifically, modeling uncertainties are set to rise as traditional actuarial models struggle to account for non-linear, rapidly changing climate risks.Looking ahead, Solidum projects an influx of climate-specific products, such as parametric insurance tied to weather indices or crop yields.Meanwhile, high-risk locations like coastal zones or wildfire-prone regions may also face sharp premium hikes or policy non-renewals, and in some cases, insurers may even exit certain markets entirely, which could lead to limited competition and sharper price hikes..

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