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ILS appetite diverges after secondary peril losses

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The ILS market has reached an “adolescent” stage of development which presents both challenges and opportunities for expansion into new products, a panel convened by Trading Risk for the ILS Week event discussed today.

The group also said that investor interest in the sector remains strong despite the losses and trapped capital of recent years.

Mike Millette, co-founder and managing director at Hudson Structured Capital Management (HSCM), said the market volatility during 2020 caused by Covid-19 has demonstrated to investors the value of alternative investments with low correlation.

However, he added: “At the same time, investors have now experienced four years of disappointing cat experience. By disappointing I don’t simply mean that there was a great deal of catastrophe activity, but that the nature of that activity was not exactly what people expected.”

Millette said this has focused investors’ attention on the standard of estimates they receive about products’ performance, adding that the industry will face “cross examination” at the mid-year renewals and that he expected overall ILS capacity to remain flat.

Philipp Kusche, global head of ILS and capital solutions at TigerRisk, agreed that the performance of ILS products has been subject to intense scrutiny.

“We see continued focus on benchmarking” he said, adding that investors have “put a spotlight” on how fund managers assess their risks and construct their portfolios.

Anne Middleton, head of ceded reinsurance and capital modelling at Convex, said that for buyers of ILS cover, the frequency of events and growth in losses from secondary perils “has created a binary behaviour”.

She said that carriers looking to secure capacity on “pretty clean” risks would be “fairly overcapitalised” with pricing beginning to fall, but added that capacity was more challenged on accounts that were loss-affected or covering a broader range of perils.

Aurora Swithenbank, CFO at Vantage, said the losses of the past four years have pushed investors to seek different opportunities in ILS.

“There is a lot of demand from investors, but it’s really in certain pockets,” she said, citing peak perils as more in favour.

“Investors want to play further up in the stack where you aren’t touched as much by those attritional losses that are coming through by secondary perils.”

Swithenbank added that investors were also focused on liquidity, looking at more liquid structures such as cat bonds.

Millette added that capital trapping is still an issue that must be addressed.

“We had a glorious decade before Harvey, and that drew so much capital into the market and now we’re living through the adolescence of collateralised reinsurance and dealing with trapping is really urgent for the market,” he said.

“It’s urgent for cedants so that they can continue to use this market well.”

Millette added that the market must also get to grips with lesser-modelled losses, citing the pandemic and the Texas Big Freeze as examples.

“Everybody talks about black swans but as far as I can tell, some of these scenarios are like black crows: they are coming around all the time,” he said.

“One black crow is that you have a pandemic and it instigates shutdowns which instigate $10bn in property losses. Another one is you have Texas freeze that instigates an Ercot failure that takes advantage of terrible building codes in Texas. How many of these black crows and grey swans are there running around?”

The panel agreed, however, that despite these challenges, there is a vast opportunity for the market to expand into non-cat protections.

Swithenbank said that even prior to the run of historic cat losses in the past four years, the market was shifting into other lines.

“You’ve seen lines like life insurance, some very big, very successful life sidecars, which are very long in duration, attracting a different type of investor or perhaps different pockets within the same investors,” she said.

“There has been an appetite for longer-tail risks, less well-modelled risks, non-elemental risks. Perhaps some of the loss patterns over the last few years will accelerate some of that interest but I think it’s been percolating for a long time,” she said.

Kusche agreed: “We always believed that investors are sophisticated and often have an interest to support other lines of business.

“Legacy is another example. We placed a sidecar for legacy business at the end of last year. There is interest from investors and the sophistication to understand other lines of businesses. The key is risk assessment, a highly aligned structure and transparency.”

Middleton said the expansion into other lines of business was a “natural continuation of risk transfer into the ILS market”.

She added, however, that this expansion has complexities to overcome, such as “the tie-up of funds…and how you design that in a way that protects the risk transfer while also protecting the intended returns of the investor”.

Swithenbank added that with virtually all other asset classes highly overvalued, investors are asking “where do you put your money today?”, and this hunger for returns will drive them to explore forms of investment such as non-cat collateralised reinsurance assets.

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