ILS: Progress in leaps and bounds

Sponsors and investors showed continued interest in ILS last year, with record-breaking issuance and over $12 billion of new capital brought to market, and the Bermuda Stock Exchange reinforced its position as the ILS listing venue of choice, as BSX president and CEO, and chairman of ILS Bermuda, Greg Wojciechowski explains.

In 2017, Bermuda issued 24 special purpose insurers (SPIs) with reinsurance exposure consisting primarily of cat bonds, collateralised reinsurance and sidecars.

New insurance-linked securities (ILS) listings on the Bermuda Stock Exchange (BSX) totalled 103 securities for the year with a nominal value of $11.54 billion. This represents a 69 percent increase in the number of new securities listed in the year and an 87 percent increase in the nominal value.

At year-end, the total number of ILS listed stood at 227 securities with a total nominal value of $25.99 billion. Bermuda’s global market share reached record levels of approximately 84 percent, cementing the Island’s continued position as leader in the innovative asset class.

2018 is on track for record issuance. There are currently a record 249 ILS vehicles listed with an aggregate market capitalisation of $28 billion. The reported outstanding value of the market is approximately $33 billion.

The 2017 events were painful to many reinsurance companies and funds but ultimately losses ended up being less than expected. For a short period there was anticipation of substantial rate increases among some market participants. However, as the scale of the losses became clearer, the anticipated rate increases did not materialise.

Growth and advantages

Growth has been driven by large inflows of capital into the sector from investors ranging from retail, and family offices, to endowments/foundations and pension funds. These investors are global, coming from the US, Europe, and Asia.

In the past decade ILS has grown its share of the natural catastrophe market and its penetration into other exposures as innovative financial techniques are developed. In comparison to the traditional capital markets, ILS is still relatively small in its notional issuance. Aon Benfield estimates that the broader alternative capital market space reached $89 billion at year-end 2017.

In contrast, the OECD total pension fund investments were $25.4 trillion at year-end 2016. The supply-demand imbalance for ILS as a non-correlated asset is another reason that the rate increases post the 2017 events were so muted.

Pension funds are attracted to the class because of persistent low yields in other asset classes, as well as years of not meeting their assumed discount rates/return hurdles as a result of the dot-com crash and the financial crisis.

The ILS market was essentially tested in 2017 and demonstrated its resilience and ability to respond. This represents a significant achievement and is testament to the strength of the industry. There was no material drain on capital. We believe this gives investors confidence in the asset class and willingness to maintain and even increase their allocation. As assets under management allocations to alternative investments increases, appetite for ILS as an alternative asset class should increase as it becomes more mainstream.

The devastating natural catastrophe events in 2017 demonstrated Bermuda’s resilience, tried and tested infrastructure as well as expertise in property catastrophe. This reinforced Bermuda’s leading global position, longevity in the market and natural choice for SPIs and ILS.

Bermuda’s advantages:

• Speed to market;
• Tax treatment;
• Expertise in property-catastrophe risk: catastrophe modelling, actuarial and underwriting;
• Regulation;
• Reputation in risk management and innovation; and
• Infrastructure & technology.

Can Bermuda do more?

Continued education and awareness of the ILS asset class and its non-correlating features with the financial markets will remain of interest to institutional investors and fund managers with strategies looking to improve risk-adjusted returns and with an appetite for alternative investments. As we see more volatility in global markets, the interest in allocation to truly low correlated assets like ILS should continue.

The protection gap is the non-insured natural catastrophe exposure throughout the globe that is a problem for emerging and developed nations alike. Swiss Re estimates that the global protection gap for weather-related risks is at least $180 billion.

Emerging markets and developing nations will provide additional opportunities to develop new ILS products and solutions as GDP growth occurs. Increased climate change risks as well as the growth in the protection gap provide more opportunities for ILS solutions to manage these risks.

As emerging markets gain in prominence with leading global markets, we see the desire for governments, industry, financial markets and stakeholders to work together. With an established track record of agility and flexibility, we believe Bermuda to be a leading incubator for insurance and reinsurance risk innovation.

Bermuda has demonstrated its leading role in risk innovation and a solution-oriented approach, which will naturally attract ILS ventures.

Pro-ILS market initiatives

It is clear from the activity level in the market and interest from investors that the capital market continues to be interested in the ILS asset class. This is evident from the increase in the number of ILS vehicles that have chosen Bermuda as their location of domicile and the BSX as their international exchange listing venue of choice.

Bermuda will continue to work with and support this maturing asset class as the risks being transferred diversify. This continued evolution of the market will go a long way in helping close the protection gap that exists today.

The BSX will continue to work with the market to help deepen exchange support which could include secondary market price discovery, trade and post-trade support.

How has 2018 started for the ILS market?

• Rate increases at renewal were lower than many had predicted.
• Traditional reinsurers’ capital remains relatively unchanged. 2017 losses did not create a capital event.
• There has been a significant amount of interest from existing and new investors.
• ILS investors have reloaded for June 2018 Florida business.
• Q1 2018: a record quarter for ILS demonstrating it has bounced back after 2017 losses.
• More M&A activity seen in early 2018 showing ILS to be a strategic component in motivation for acquisitions allowing broader access to alternative capital pools and lower reinsurance costs.

Long-term trends

In the last few years ILS capacity has migrated from private equity investors to family offices and now to pension funds. In the last few years ILS capacity has migrated from private equity investors to family offices and now to pension funds. This migration has accelerated in the 10 years since the financial crisis as pension funds globally realised that many assets previously sold as low-correlating assets were in fact not, as well as the growing maturity of the ILS market.

This migration has been from capital providers with higher, equity-like costs of capital to lower cost capital providers and has been driven by the ILS market’s maturity in three main ways. First, the asset class was tested in 2011 and substantially in 2017 by loss events. Second, there has been substantial growth in ILS assets over the period as well as an increase in managers of ILS strategies and consultants and others focusing on the asset class. Finally, financial engineering techniques have been developed to allow access to other exposures besides natural catastrophes.

These forces are unlikely to be diverted in the short to medium term and the lowering of barriers to entry to the space will lower returns for the ILS, reinsurance and insurance industry as a whole. This will result in fewer insurance and reinsurance balance sheets as re/insurers seek scale to manage their expense ratios on reduced margins on the underlying business.

Simultaneously, there will be a greater pool of capital provided by ILS funds seeking to access the non-correlating returns that can be accessed from re/insurance exposures. This evolution will result in mainly idiosyncratic re/insurance risks being held by re/insurers with efficiencies in transformation techniques resulting in ILS capacity assuming more and more severity risk that is seen to be non-correlating to the broader financial markets.

• Reinsurers desire simplification and continue to look for efficiencies, innovative products and digital transformation.
• Collateralised reinsurance will continue to provide a greater portion of retrocessional capacity to the reinsurance market.
• Diversification by peril—we are seeing a trend in the percentage of outstanding capacity exposed to US wind with current exposure being the lowest in the last 10 years.