Trapped collateral remains a growing concern for ILS investors

Trapped collateral remains a growing concern for insurance-linked securities (ILS) investors but there are solutions available and this is one area where new technology can prove its worth, according to Will Dove, the chief executive officer of Extraordinary Re.

He told Monte Carlo Today that in recent years events such as hurricanes, typhoons and California wildfires have led to many ILS instruments yielding returns that are below expectations. On top of this, it can take a long time for the industry to quantify the loss from events such as a hurricane hitting Florida. This can dent investors’ appetites.

“As of a couple of months ago there were still 45,000 open claims from Hurricane Irma which occurred in 2017,” Dove said.

“With a significant number of claims still open, the result is loss creep and it has put the spotlight on some of the structural weaknesses and constraints in the ILS instruments.

“The ceding companies have the right to hold on to the collateral and for the investor that’s a very troublesome event.

“These trapped collateral issues mean they are not able to deploy that money into new opportunities; it hurts their returns and has been a recurring problem and is going to become more pronounced, partly due to COVID-19.”

Extraordinary Re’s Nasdaq-powered trading platform uses cloud technology to enable investors to trade assets tied to insurance liabilities, and one of its key advantages is the fact that it enables investors to address the problem of trapped collateral.

“That is exactly what we have created our platform to be able to do,” said Dove.

“If an investor signed up to a transaction covering 2020, at end of the year if there are losses that could potentially trigger the coverage, the investor could just hold on and keep the capital there and hope they get the money back.

“Or they can trade that position, and if there is another investor, perhaps a run-off investor interested in taking on the tail of that transaction, there may be an ability to have a price agreed between the two parties.”

Trading market
Dove believes the liquidity this creates is a key differentiator for the platform, which was founded in 2012 and was established as an insurance company in Bermuda in 2018. The company has now passed through a period of busines plan development with the Bermuda Monetary Authority (BMA) and is actively in discussions with investors, brokers and insurance companies.

“Our vision is to create the first trading market for insurance risk, and to do that we built out the technology and legal infrastructure to support the trading of insurance liabilities,” said Dove.

“We have developed technology that allows investors to create customised portfolios of insurance risk and manage them dynamically it’s that liquidity that has been absent and is an important feature to make that market more efficient.

“It’s not for everybody; there are some investors happy buying and holding risk but a number of more sophisticated institutions, especially pension funds, want to have the ability to trade.”

Asked about other key concerns in the ILS market, Dove said that while property cat risk is still is the core of the ILS market, there are investors thinking about new types of risk, ranging from flood to run-off liability. One of the key features of Extraordinary Re is that it will facilitate the trading of a wider range of risks than have been traditionally addressed in the ILS market.

He added that the World Bank’s pandemic financing facility has created a lot of interest in how to cover pandemic risk, and that ILS capacity is likely to form part of the solution.

“It’s hard to spread that risk but there are a number of efforts under way to create public-private partnerships and almost all those models contemplate some role for ILS capacity for some of those problems,” he said.

“The impact of COVID-19 on the insurance and financial markets has enhanced the need for platforms like Extraordinary Re to connect with capital markets.”

He added that investors are concerned that one of the weaknesses of the insurance market is that prices reset only once a year, so investors value the ability to discover prices in the interim and gain some idea of what each position is going to be worth.

“It will attract more participants and will create a vehicle that accesses much larger pools of capital for the very large risks that we face.

“Pandemic is the most recent example, but climate change and cyber risk and others are also areas where there is much less insurance penetration than would be optimal,” he concluded.