What’s in a promise to pay? That was one of the questions that was circulating at this year’s Monte Carlo Rendez-Vous, as a couple of unhappy cedants clamoured for ILS funds to meet claims that – in the ILS manager’s view – had been extinguished.
The issue has arisen as a by-product of gradual loss creep from Hurricane Irma over the course of this year. Collateralised reinsurance typically provides a mechanism for reinsurance buyers to keep back collateral after the end of a contract, using a margin above current reserves to allow for losses to develop.
But in some cases, loss creep had been so extensive that these buffers proved to be inadequate, and the cedants were left bearing the loss.
Even though the ILS and reinsurance markets have made great strides in mingling and converging with each other in the past decade, there remain issues such as this that disturb the fault lines of discord.
Many within the ILS market see a commutation as something that should draw a line under the business – a regrettable but avoidable error, with the onus on the cedant to have managed its reserves better initially.
But within the traditional market – and even pockets of the ILS sector – some are seeking to capitalise on it as an example of companies failing to meet the “promise to pay”.
However, it’s a risky play to get into gamesmanship, as it can invite questions or rebound more broadly on the industry.
At the end of the day, there is no way around credit risk of some kind – either you put faith in an A- rating from an agency, or you hope ILS managers will top up collateral funds.
The benefit from these incidents is that they will put more emphasis on paying attention to variations in terms and conditions of cover.
Not all solutions to this issue will be the same – but as always, it will come down to a question of price.
Had Irma been the big Miami disaster that it initially threatened to be, no doubt reinsurance buyers would have felt more secure with cash in trust accounts in their favour.
But because it was a smaller but more prolonged loss, it turned into the kind of claims event that is more easily handled by rated paper in the long-term.
Cedants have undoubtedly benefited from hugely discounted cover in the past five years due to ILS competition.
But locking up collateral over the long-term may come at a cost.
To view the Monte Carlo Roundtable supplement, please click here.
Fiona Robertson, Managing Editor, Trading Risk