Interviews from the networking event for the insurance-linked securities, alternative reinsurance, and convergence marketplace held in Hamilton, Bermuda. The following are interviews from A.M.BestTV’s coverage of the event.
- Meg Green
- December 2018
The next phase of insurance-linked securities is 'reverse convergence.'
Several insurance-linked securities funds have expanded by setting up their own reinsurance entities, with more expected to follow, said Anup Seth, managing director, Aon Insurance Managers (Bermuda) Ltd.
How has the ILS market fared after the 2017 natural catastrophes?
I think the industry has fared really well after the 2017 storms. In fact, most of the ILS funds actually reloaded prior to the January 1 renewal season. When you look at the amount of capital that is now within the alternative sources—Aon does a report every year just before Monte Carlo—the total assets under management or capital that's coming from the alternative sources now stands at just under $100 billion. That represents an increase of 10% over the previous 12 months.
When you stand back and look at the total reinsurance capital that we have in the market, that stands at around $600 billion. Effectively, one in $6 is now coming from this alternative source. It is becoming a significant part of the overall market. They fared really well, and they're here to stay.
How are ILS funds accessing new business?
Historically, ILS funds are focused on property cat retro or property cat reinsurance. One of the trends we're seeing now is that they're looking to access more direct insurance business, and they're doing that either through a fronting partner, or they'll do that through an MGA relationship that's linked to a fronting partner.
I think some of the acquisitions that we're seeing are accelerating those strategies. The recent announcement of Markel acquiring Nephila, I think that will accelerate Nephila's strategy of accessing direct business. Similarly, when we were in Monte Carlo, Brian Duperreault was very vocal about AIG's strategy around how they want to use their ILS vehicle—AlphaCat—moving forward in this space. I think that's a clear trend now that we're seeing, these ILS funds wishing, or willing to, or wanting to access direct insurance business.
How are ILS funds themselves evolving?
Given the size now, these ILS funds are looking at their own structures and looking to see what is the most efficient way to deploy this capital. One of the things we're seeing in Bermuda, in particular, is that these funds are setting up their own rated reinsurance entities. They're starting off with perhaps a Class 3A entity to take advantage of the Solvency II equivalency that Bermuda offers. Then as they graduate, and build further, and grow further, their plans are to get these entities rated. We saw that a couple years ago with Lumen Re here in Bermuda, and I think we will see that trend continuing as well.
That's almost a reverse convergence?
It is, yes. The phrase that we're coining here is reverse convergence.
What new perils is the market looking to cover now?
One of the things the funds are looking at is how to diversify their portfolio. We're certainly seeing other credit insurance coming into play, so mortgage insurance bonds. The premise is really that these risks have to be non-correlated. Mortgage insurance is not that. It is correlated to the wider macroeconomic industry. Investors, they are different, and they have a different appetite. I think some of the newer perils like cyber, like broader operational risk, I feel will come into play.
More importantly, more recently, I think life insurance is a great way to diversify a book. We have seen a couple of large ILS funds set up their own life funds. What they're doing in that space is they're providing liquidity for life insurance companies. They're able to do that by monetizing or securitizing the economic value that's embedded within a portfolio of life insurance policies.
Then the second area where I think—and this is more the future of what I believe life ILS funds will look to provide a solution for—is longevity risk. If you just look at the U.K. market, there's significant longevity risk that's uninsured. These pension funds are looking to de-risk their pension portfolios, de-risk their schemes. I think ILS funds, if they can provide a suitable solution, that'll be a great source of diversification for them.
Industry expert says convergence capital could ultimately go retail.
The continued growth and diversity of risks being covered by convergence capital means smaller investors eventually might have ways of allocating funds toward insurance-linked securities, said Andre Perez, chief executive officer of Horseshoe Group.
Earlier this year, you discussed the potential threat of trapped collateral in the ILS space. Can you tell us about that?
Last summer we had three big hurricanes in the U.S., Irma being probably the most significant one of the three. Because they happened toward the end of the year, one of the mechanisms in collateralized reinsurance is that if there's a significant loss, there's a formula by which the collateral is not released on time, to put the collateral toward the next year's transaction. We thought it would be a problem, because a lot of collateral was going to be trapped.
Will ILS funds and ILS investors have sufficient capital to reload, if you will, and renew other transactions? We thought it was initially a problem, but we didn't anticipate the speed at which a lot of ILS funds not only replenished and raised additional funds to go back to where they were before the three hurricanes, but most of them actually raised even more funds than what they had before. I think net net, we ended up with something like 10%-15% additional assets in the ILS space. In that sense, yes, there was still trapped collateral, but it wasn't an issue, because with the additional collateral, funds were able to reload and participate in renewals.
What does that say about the strength of the ILS market?
It's very exciting, because we at Horseshoe have been in this market for a little over 13 years now. We set up in March of '05. Katrina, Rita, and Wilma hit that summer, which I think changed the trajectory of the reinsurance market—more specifically, the property catastrophe reinsurance market—and definitely was the birth of ILS as we know it today.
There were transactions. It wasn't called, really, ILS pre-KRW or Katrina, Rita, and Wilma, but we certainly saw the major expansion after that. Since then, we kept hearing, “Oh, the next big loss, capital will go, and this market will go away. It's just a passing fad.” I've heard that for the last 13 years.
What's interesting is now, it showed that even after three significant losses, capital was still coming back into the market. I could tell you for a fact, had Irma hit Miami the way it was supposed to originally, we would have seen even more capital coming to the market. There's a fair number of people interested in ILS. The other thing to keep in mind in terms of the stability of the investor base is that we had a lot of hedge funds investing post-KRW. They have a much more aggressive investment strategy, but also that are much less sticky, if you will, in terms of investors.
Once the market condition decreased, they'll move on to the next industry. Whereas, if you look at the complexion of investors nowadays, a huge part is pension funds. The plus and the minus of pension funds investing in the ILS space, the minus, I'll start with that, is that it takes them a long time to make a decision to invest into it. The big plus is once they've decided they're going to make the strategic allocation, they actually have the staying power, which helps a lot in terms of ensuring the viability and the stability of the ILS market.
How do you see the ILS market continuing to evolve?
It's in constant evolution, let me tell you. Because that's what we do for a living, we're in the front row of the show, so we see all the activity going on. It's interesting, because if you look at ILS in general, it was basically property-cat business, predominantly U.S. exposures, so U.S. quake, U.S. wind. We had some Japanese quake as well.
You have three evolutions that have been cooking for a while, but definitely are now becoming more prevalent. One of the evolutions is the fact that ILS investors are willing to look at different risks than just property-cat business. We've been involved in transactions where they access the ILS market for operational risk or credit risk, some was a jackpot of a lottery risk. I think you're starting to see a lot more risk entering the market, and a lot of short-tail risk. The second one, which has been happening, but I think it's happening even more now, is geographic diversification, where we're now seeing ILS being done not only predominantly in the U.S. It's still the predominant territory. But we're seeing Europe, we're seeing Asia, we're seeing obviously, Australia, New Zealand, etc., so it's the expansion in terms of the geographic base of risks.
The third one, which I think is the most interesting one for me is to start seeing participation from the ILS market, what I call down the food chain, and so getting closer and closer to the risk. It started originally with retrocession, then it went with reinsurance, and now you have ILS funds participating on the insurance side. What [AIG has] access to is a tremendous book of business, and so they have the ability to package risks and be able to sell those risks to ILS investors in a way that they already have the origination, they already have the risks, as opposed to trying to generate the risks themselves.
What would be interesting to me is also to see how brokers are going to react to ILS funds going down the food chain, because a lot of brokers will tell you they own the distribution channel.
We've seen Ryan Specialty, Pat Ryan being the founder of Aon, starting to think about setting up his own balance sheet. It has its pluses and minuses, but again, it is in reaction to the fact that, “Hey, you're not coming down to my playground. I own the playground” sort of thing.
There's a lot of dynamics at play. I think that the investors' base is pretty stable. You still have new investors coming into the space, but it's what is ILS evolving to become? If you read a lot of the statistics, we're now saying we're at $100 billion. That's two years ahead of time. We thought, $100 billion, we'll hit in 2020. We're now in 2018, and we're already at $100 billion.
It tells you the speed at which this market is developing. Multi-jurisdictional, more risk, more sources of business, all of that contributes to ILS becoming more and more a bigger part of the insurance and the reinsurance market. What's really interesting is seeing a move. If you look at Markel, for example, recently buying Nephila, it's a move where you now have all the insurers and reinsurers who, 10 years ago, said, “This is a passing fad,” using the attitude of if you can't beat them, join them thing.
It's really reshaped the entire industry, hasn't it?
It has. I think definitely on the reinsurance side, and again, more specifically property/catastrophe, because that's where it all started.
If you were a monoliner, I don't think we have any more true monoline property cat reinsurers, but if we do, you'd seriously question your existence. What is the differentiating factor? Shouldn't you be a package or a risk and provide different pools of risk to different investors' appetites?
That's where I'd like it to go, is really get a lot more bespoke investment funds, if you will. I've been saying for a long time, my dream is to see it become retail. People say I'm crazy, but I'm like, “Look, why wouldn't…When I have my pension fund, and I check off 'Put 10% in equity, and 20% in bonds,' I have no clue what I'm doing anyway, so why not an ILS fund?”
That would expand even more the investors' base, but that's further down the line.
Do you see companies and entities directly tapping into the ILS space instead of going to an insurance company?
That is my only one disappointment of this market, is that I was really bullish thinking that a lot of large corporate entities would directly access the ILS market. We've seen a little bit of that. Way back, you had Disney Japan, who issued a parametric cat bond many, many years ago. I forgot the name of it. More recently, you had the Metro Transit Authority doing their own cat bond following Superstorm Sandy, so that was a bit of a sign of what was going to happen. We haven't really seen large corporations with plenty of insurance risk access the ILS market yet. I'm still hoping it will happen. I was hoping it would happen a long time ago, and it hasn't. We were approached by one large corporate looking at ILS. They're like, “Look, we don't know anything about ILS. Tell us a little bit.”
When they told me how much they were paying on their insurance program, I said, “You know what? Stay with your traditional insurers, because I don't think the ILS investors would be interested in the rate you're paying.” I wonder if part of the reason is that the insurance they're paying themselves is pretty cheap. Another look at that, any other alternative? Part of it is the fact that where ILS may play a role is, are they risks that are uninsurable or difficult to insure?
Operational Re, which is a cat bond, where the exposure is basically operational risk—trying to insure operational risk is a little difficult, if not impossible. That's a very good use of the ILS market for corporates. Hopefully that will evolve, but I haven't seen that as much as I would have liked to see it, to be honest.