According to equity analysts at investment bank and financial services specialist TD Cowen, companies in the London insurance and reinsurance market still consider ILS and alternative capital as largely peripheral, believing that it is traditional capital that drives most price pressure in the sector.In a recent report the investment bank also takes a refreshing view on interest rates, explaining that if we enter a more prolonged phase of declining central bank rates then we could see a more substantial increase in capital flow to catastrophe bonds and other insurance-linked securities (ILS).Having spent time in the London market recently to meet with leading insurance and reinsurance underwriting and broking firms, the TD Cowen analyst team have concluded, similarly to other analyst teams, that while the property catastrophe reinsurance market is headed for continued softening at the 1/1 renewals it is doing so from a very high base and remains attractive to both traditional and alternative capital in the industry.Strong returns are still possible and as a result competition is expected to rise, but the traditional companies the analysts spoke with believe third-party capital that has come in through catastrophe bonds and sidecars remains peripheral to the rate declines experienced so far.

Strong earnings of traditional underwriting companies are therefore seen as the main driver of further rate declines in property cat reinsurance in 2026, absent some kind of loss or event that drains capital from the sector.But it is seen as challenging to grow in the property reinsurance space, given the still attractive returns possible in catastrophe risks, meaning that “it is hard to lean in strongly to accelerate growth, as competitors are generally not pulling back, with companies still competing for business.” One of the London marker re/insurers that th TD Cowen analysts spoke with said that reinsurers should still be able to earn returns above cost-of-capital for a few more years, even in the currently softened environment.The analysts said that they came away with the feeling that terms and conditions remain firm with companies holding the line and seeing them as more important factors than pricing at this stage of the cycle.

Attachments continue to hold at their elevated levels and while not everyone sees this as feasible to continue, the analysts note that it will likely take over-capacity to drive meaningful change here.While new capital has been flowing, not least through catastrophe bonds and sidecar structures, the lack of new entrants and balance-sheet reinsurance start-ups means the market is not yet seeing this as a particular concern.In fact, retained earnings from the traditional reinsurance market are seen as the major driver of excess capital at this time, the analysts say, given the cat bond market is located in a specific area of the industry risk tower, while sidecars and other structures are supportive of traditional reinsurers’ ability to write even more risk.

Moving on to the TD Cowen analyst comments on what the trajectory of interest rates could mean for the ILS market.It’s often been seen in the past that declining interest rates has been said to be a factor in lowering the attractiveness of cat bonds and ILS for investors.In fact it’s been an area where opinions have differed consistently over the decades we’ve been tracking this space.

Some reporters and analysts persist today in suggesting that ILS capital would likely decline alongside interest rates, with investors losing some of their appetite for the asset class as the floating rate component of the market yield shrinks.But, as we’ve explained many times before, investor’s attraction to ILS is not bound up in the fact they are floating rate instruments, that deliver a risk-free collateral return which is loosely linked to interest rates.Far from it.

The main driver of investor attraction to the asset class is the insurance risk spread, or discount margin and the fact this is relatively uncorrelated to broader financial market instruments and other asset classes, while truly diversifying for their portfolios.As interest rates decline, investor appetite for ILS could actually increase, as it makes the diversification opportunity seem even more evident in a world of lower rates and the asset class becomes relatively more appealing as a result.Something the TD Cowen team has recognised by saying that, “If we enter a period of declining interest rates, there could likely be an increase in the pace of alternative capital entering the reinsurance market through catastrophe bond / other insurance-linked security structures (as there has been in the past).” The floating rate component is an added driver for investors, but the main attraction to catastrophe bonds and ILS remains in their relative lack of correlation and diversifying properties, something that persists through interest rate cycles.

Those properties can shine in an environment where central bank rates are shrinking, so TD Cowen is right to point that out.But they continue to shine when interest rates are on the rise as well.Of course, given the macro-economic outlook and spectre of inflation hanging over advanced economies still, there’s no guarantee the rate cutting cycle we saw begin with the Fed in recent weeks will persist for especially long this time and the general feeling is that the floating rate component of ILS market returns will likely remain at levels where it remains an added attractor to the asset class for investors anyway..

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