Newcomers add depth to the ILS sector

It has been another manic month within the ILS space with yet more reinsurers ensuring they have the tools necessary to participate in this rapidly growing market but, perhaps more significantly, a number of new issuers using these markets to offset their risks for the first time.

One of the big points of debate in recent years has been whether the market can continue to diversify bringing new risks, new issuers and new structures to the sector in a way that will allow the market to continue to grow.
Some of the deals in recent months would certainly suggest that this is already happening. Some of the new issuers have brought firsts to the market in terms of risks, while yet more reinsurers are positioning themselves to operate within this space.

Perhaps the most innovative bond to have been launched in recent months was by first time issuer First Mutual Transportation Assurance Company, a New York State-licensed and domiciled captive insurance company and subsidiary of the Metropolitan Transportation Authority (MTA).

MetroCat Re is a newly formed catastrophe bond shelf programme and this deal became the first to protect against storm surge risk. The notes are rated BB- by Standard & Poor’s and have an expected maturity of August 5, 2016.

GC Securities, the sole bookrunner, joint structuring agent and lead manager on the deal, announced the placement of the Series 2013-1 Notes with notional principal of $200 million. The bond provides three years of per occurrence-determined storm surge height protection as measured by up to five calculation locations in the New York City metropolitan region during the event period of a named storm.

“In the aftermath of Superstorm Sandy, the traditional avenues we use for insurance and reinsurance contracted dramatically, making it exceedingly difficult for the MTA to obtain insurance,” said Thomas Prendergast, MTA chairman and CEO.

“We appreciate the contributions of all of our business partners. This strengthens our position with regard to future interactions with the traditional reinsurance market. We anticipate that this deal represents the start of a long-term alternative reinsurance option that diversifies MTA’s risk management strategy.”

David Priebe, vice chairman of Guy Carpenter and head of GC Securities, added: “The remarkable convergence of capital markets capacity with the reinsurance market that has been witnessed in 2013 to date is also applicable to the insurance markets, as is evidenced by the successful MetroCat Re cat bond issuance benefiting FMTAC. Capital markets investors embraced this new peril and sponsor. Marsh and McLennan Companies is committed to leveraging the GC Securities platform for the benefit of all its operating companies’ clients.”

New kids on the block

A similarly interesting new issuer in the market was New Jersey Manufacturers Insurance Group (NJM), which launched Sullivan Re Ltd (Series 2013-1), a $60 million cat bond issued with the help of Towers Watson Capital Markets (TWCM).

"In the aftermath of Superstorm Sandy, the traditional avenues we use for insurance and reinsurance contracted dramatically, making it exceedingly difficult for the MTA to obtain insurance."

The private placement cat bond came to market in July and provides NJM with a three-year source of reinsurance protection for a single layer of its reinsurance programme. The coverage provided is on a per-occurrence basis and the cat bond is structured using an indemnity trigger, linked to NJM’s losses in New Jersey and Pennsylvania.

“Following NJM’s 100th anniversary earlier this year, we are pleased to bring its first ILS transaction to the market,” said Ed Hochberg, president, TWCM. “Sullivan Re will supplement NJM’s risk management to help ensure that the company continues to satisfy its obligations to its policyholders for years to come.”

Rick Miller, TWCM’s co-head of ILS, added: “As a three-year deal, the cat bond provides the cedant with an added dimension to its overall programme. By working closely with our brokerage colleagues we are able to bring the most comprehensive solutions in the markets to our cedants.”

Michael Popkin, TWCM’s co-head of ILS, said: “The ILS market continues to transform traditional reinsurance while becoming more accessible to smaller players. This is creating a market trend we expect to continue, where new cedants are eager to develop instruments that investors want to participate in. We’re very pleased our team can fill this important role for new cedants by bringing their perils to the ILS market.”

Another new sponsor to the market this summer was AXIS Capital Holdings, which issued Northshore Re Limited (Series 2013-1), a $200 million cat bond that provides AXIS Capital with multi-year US hurricane and earthquake protection on an annual aggregate and industry loss trigger basis. The deal grew in size and dropped in price during marketing.

RenaissanceRe, although not a first-time issuer, brought its first widely marketed 144A catastrophe bond to the market, providing the reinsurer and joint sponsor RenRe’s joint-venture reinsurance vehicle DaVinci Re, with a $150 million source of multi-year retrocessional US hurricane and earthquake reinsurance protection. Mona Lisa Re Ltd (Series 2013-2) has transferred a $150 million portion of its named storm and earthquake risks to capital market investors.

Meanwhile, yet more reinsurers are launching vehicles that will allow them better to tap into the vast potential capital markets money clearly holds for the industry and three more companies have launched new ventures in recent months.

Kane, the global insurance manager, has launched a new independent private catastrophe bond platform. The company said the platform could facilitate the flow of smaller transactions into the collateralised reinsurance sector.

The Kane SAC Limited Note Program has also issued its first notes—some $9.5 million of Series 1-2013 Notes, which have been listed on the Bermuda Stock Exchange (BSX). This is the first instance of a series of notes issued by a segregated accounts company being listed on the BSX. The ceding insurer of the notes is the Texas Windstorm Insurance Association-—another new issuer.

Robert Eastham, managing director of Kane (Bermuda), said: “We are delighted to be able to launch our new catastrophe bond platform by announcing the issuance of the Series 1-2013 Notes. Our decision to list the notes on the BSX was due to investor demand and means that they are now available in a tradable format, which we feel will significantly heighten their overall value to the investment community.

“Moving forward, we see this platform playing a key role in facilitating the flow of smaller transactions into the collateralised reinsurance sector. Our goal is to reduce both time to market and structuring costs by providing a very standardised and efficient means for investors to access the reinsurance markets.”

Lancashire Holdings has revealed more details about its recently formed Lancashire Capital Management division. It will focus on managing third party capital to be deployed in Lancashire’s underwriting and expects to be using capital by the January 1, 2014 renewals.

In a statement covering its second quarter earnings, the company said the division has been named Kinesis Capital Management and that encouraging discussions are taking place with both investors and clients.

"The process is radically different from a traditional retrocession or reinsurance, and is a more complicated path to tread; this is exacerbated, or perhaps caused, by the minefield of legislation."

Elaine Whelan, Group CFO at Lancashire, said that Kinesis Capital Management and a Bermuda-domiciled special purpose insurer Kinesis Reinsurance I (Kinesis Re) were both established on Bermuda in the second quarter. Darren Redhead, who joined Lancashire in March, will serve as CEO of Kinesis Capital Management. Mathieu Marsan, an experienced actuary and risk modeller, will also work in the unit.

Whelan said that third party investors will invest in segregated accounts in Kinesis Re, giving them access to specific underwriting opportunities. It expects to begin deploying capital by the January 1, 2014 renewals. Goldman Sachs has been engaged as the placement agent.

XL Group and private equity firm, Stone Point Capital, have formed a Bermuda-based company which will act as an investment manager in ILS and other reinsurance capital markets products.

The focus of the company, which will see XL with a 75 percent ownership stake and funds managed by Stone Point at 25 percent, will be on ILS and index-linked products as well as on XL-designed reinsurance products. The parties intend to invest up to an aggregate of $135 million in funds to be formed, alongside potential third party investors.

The new company will offer investors access to both capital markets and traditional products, including certain risks currently written by XL.

“Given the combined strength of XL’s 20-plus years of world-class reinsurance underwriting expertise and Stone Point’s proven track record of investment success in the insurance and reinsurance sectors, this initiative fits perfectly with XL’s continuing objective to offer innovative products to our clients and enhance profitability and long-term value for shareholders,” said XL chief executive officer, Mike McGavick.

Charles Davis, Stone Point’s CEO, added: “Stone Point is delighted to be partnering with XL on this venture. Stone Point’s relationship with XL dates back to 1986 when our team assisted with the formation of the company. We believe that the convergence of the traditional insurance and reinsurance markets, and the capital markets will continue. This initiative with XL is designed to offer third party investors an opportunity to invest in this asset class in partnership with one of the world’s premier reinsurance underwriters.”

Too good to ignore

Looking at trends in the wider cat bond market, it is easy to see why new issuers are increasingly deciding that it is simply too attractive to ignore.

New catastrophe bond issuance for the first half of 2013 was $4 billion, the highest level since 2007, and $17.5 billion was outstanding as of June 30, 2013. According to an ILS second quarter update report by Aon Benfield, pricing is now some 40 percent lower than in the fourth quarter of 2012 and the markets are consistently offering more aggressive pricing than the traditional reinsurance market.

Perhaps the difference is not quite as pronounced as it may seem, however, with the issuance of cat bonds still attracting higher administration and legal costs than traditional deals. The views of James Illingworth, chief risk officer of Amlin, were quite revealing in comments published in Aon Benfield’s report. Amlin recently launched its second bond, Tramline Re II.

“Having already established contacts on both the legal and structuring side through the issue of Tramline I, we felt that our second issuance would be easier. Certainly we were pleased with the collateralised nature of the coverage available and intended to utilise the capacity within the capital markets again. The attractive price compared to traditional coverage (albeit with the additional basis risk), coupled with the ability to sustain that price over a four-year period, was also an obvious advantage,” he said.

But he added: “The process is radically different from a traditional retrocession or reinsurance, and is a more complicated path to tread; this is exacerbated, or perhaps caused, by the minefield of legislation which sponsors have to navigate. These structures can appear complex, expensive and impenetrable to the uninitiated.

“We hoped our second bond would be a simpler exercise, and in many ways it was, but we still had to employ six separate law firms as well as our in-house legal team to get through the process. Therefore, the associated costs of such transactions can only be justified by larger bond issues likely to come from larger sponsors.”

In its own recent report on the ILS market, The Storm Before the Calm, Willis Capital Markets also makes the point that for the ILS market to continue to grow, it must expand beyond customary natural catastrophe perils and investors will need to accept a growing pool of perils.

“Some of these are evolutionary and not revolutionary. Think earthquake risk in places such as Columbia, Chile, Israel and even China. Others may represent a more radical departure from market norms. For example, will investors accept standalone US terrorism risk if the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) is non-renewed? Will casualty risk finally become more at home in the capital markets?” the report asks.

The report also noted that as deals become more complex in their structures and terms and conditions, it is important that a high level of transparency is maintained—one bad deal could tarnish the entire market.

“To continue the same pace of growth we have seen in the last few years across cat bonds and collateralised re, sponsors will need to deliver and investors will need to accept a growing pool of perils,” the report said.

On terms and conditions, the report said that along with a rapid decrease in spreads in the last few quarters, terms and conditions have become increasingly flexible with some deals even having ‘name your own reset’ provisions allowing firms to change the risk-return profile (within a range) on an annual basis.

“To some extent investors can price for these changes and should even welcome them if they bring more sponsors and deals to the market. This is particularly true if the high standards for transparency in both structure and collateral mechanisms that followed the financial crisis remain in place. On the other hand, a few bad apples (or sloppily structured deals) can spoil things as investors will assume that deals have hidden time bombs and price all new deals accordingly,” the report warned.

Cautious optimism

New issuers are increasingly moving into this space but will costs continue to fall and a growing range of risks become available? That, it seems, will be the big question going forward.

In that same Willis report, Luca Albertini, the chief executive of Leadenhall Capital Partners, sounded optimistic.

“With the investors’ requirements meeting the protection buyers’ needs, and with investors and capital markets players being innovative in creating extra protection products which complement the traditional markets, we may well one day be two to three times the current size,” he said.

“There are two main threats to this growth: i) surprises (ie, losses which are not in line with what the marketing effort showed being in the range of the possibilities), and ii) the investor community not maintaining pricing discipline and being recognised as the cheap source of capacity which is arbitraged by the reinsurance community.”