The cat in the (aluminum foil) hat: cyber and other specialty risks to drive ILS growth

16-11-2016

The cat in the (aluminum foil) hat: cyber and other specialty risks to drive ILS growth

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An investment in innovation to bring new risks to market is crucial to the future of the ILS sector, says Tom Johansmeyer of ISO/Verisk Insurance Solutions.

The most popular way to attain profitable growth, it seems, is just to wait for the market to harden. All it takes is a little patience, right?

Of course, that isn’t realistic. The pressures to drive results for one’s stakeholders are agnostic to reinsurance rate trends. We have no choice but to press on. And it’s not as if a major catastrophe event would change the market anyway. With reports swirling around of a market-hardening loss needing to exceed $200 billion, we’re basically stuck waiting for one of the following:

  • Asteroid with ‘ice age following’: We have more than 100 million years of data but really only one meaningful loss event. Alas, dinosaurs didn’t have the right cover, and the problem may have been winter storm hours clauses.
  • Zombie apocalypse: There’s no historical data here, but if you model it out deterministically, you’ll probably find several clash scenarios that need to be addressed. Look out for ‘war on land’ exclusions, particularly if a coordinated government response arises. 
  • Alien pandemic: Again, keep clash in mind. The challenge here will be determining whether the event was state-sponsored and whether extraterrestrial states are excluded.

Even in the scenarios above, there’s the potential for widespread carnage under exclusions that would minimise the loss—and thus not turn the market. Clearly, an investment in innovation to bring new risks to market is crucial to the future of the insurance-linked securities (ILS) sector.

“The ILS market needs access to new types of risk. The specialty market seems to be the right place to start.”

The ILS space has relied heavily on property catastrophe risk since its inception, and most of that comes from the US. So, it’s no surprise that catastrophe bond issuance activity is at the mercy of global reinsurance pricing trends. And when traditional cover seeks to protect its turf, the result can be a drop in issuance—as we’ve seen in 2016. To attain sustainable growth and drive greater returns for end investors, the ILS market needs access to new types of risk. The specialty market seems to be the right place to start.


Specialty risks

To be fair, it’s not as though the ILS market has made no attempt to bring in new risks. Sponsors have completed medical benefit, mortality, operational risk, and even some corporate catastrophe bonds.

They’ve provided occasional market growth but lacked the scalability, apparently, to make that growth sustainable. One-off catastrophe bonds simply can’t provide a foundation for ongoing market expansion.

What makes specialty risk different is that everyone seems to want it. Cedants have a clear need to transfer that risk, particularly with terms they may not be able to get in the traditional reinsurance market.
And the ILS community is hungry for diversifying risks—not to mention more risk in general. Some specialty risks could require vast amounts of capacity—if written to address cedants’ broader coverage needs—which would help absorb much of the capital overhang that exists because of global pension fund target allocation levels. 

Cyber risk comes to mind immediately in this regard. While the market is small today, considerable pent-up demand likely exists, and it probably will only grow. Existing cover doesn’t necessarily address the full underlying threat. A close look at the cyber market can make you want to don an aluminum foil hat, start a large vegetable garden, and breed rabbits in case you’ll need a source of meat later. The risks are real and large. With the amount of capacity that could flow into the ILS market to support new risks, the connection here is salient.

Terror is another. Should the existing terror threat shift from active assailant to ‘trophy’ targets, global insurers and reinsurers could sustain profound losses. And the soft market tendency to expand areas of coverage in global aggregates has led to higher terror accumulations.

Marine and energy has long needed a new approach to risk transfer, especially in the retrocessional space. The capital markets appear ready to assume much of this risk, as long as a credible index can be brought to bear (PCS is actively working on this).

What these three risks have in common is the ability to scale. Cedant demand is market-wide, rather than being unique to a particular company. A ‘proof of concept’ transaction would likely lead to several more in fairly short order, resulting in a large collection of new risks coming to market.

Of course, these are smaller markets right now, but the engagement of the ILS community could make them somewhat bigger smaller markets and provide the first step toward the absorption of existing capacity and the benefits of an increased risk base. None of these lines is easy, but solving the hardest problems often drives the greatest returns.


Tom Johansmeyer is assistant vice president, reinsurance services, marketing at ISO/Verisk Insurance Solutions.
Contact him on: tjohansmeyer@verisk.com

Verisk Insurance Solutions, ISO, Tom Johansmeyer, North America, Insurance, Reinsurance, ILS, ILS market, ILS issuance, Property, Casualty, Risk management

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