Where the new ILS opportunities lie — and how to access them
A significant motive for bringing insurance-linked securities (ILS) to new geographies is diversification of portfolios, according to Henri Winand, founder and chief executive officer of AkinovA. Speaking in an Intelligent Insurer Re/insurance Lounge webinar titled “New domiciles, new risks, new structures: another evolution for ILS”, he noted that while an attraction of ILS is that it is seen as uncorrelated from the capital markets, it has a disadvantage in that portfolios are largely concentrated in North America, and to some extent in Asia.
“Bringing in new regions so that portfolios are not all concentrated or moving up or down at same time is important,” Winand said, adding that to facilitate this, there need to be local regulatory frameworks in place that replicate aspects of Bermuda’s rules.
He added that a degree of education is needed for new investors—for example around issues such as trapped capital.
Geographical opportunities
One area that offers significant potential for the introduction of ILS is the region covered by China’s Belt and Road Initiative (BRI). These countries are largely unsupported by insurance and ILS is an attractive option, according to Kirill Savrassov, chief executive of Phoenix CRetro.
Speaking in the same Re/insurance Lounge webinar, he explained: “Those countries are receiving billions and billions of investment into their transport and critical infrastructure but remain uninsured and uncovered for large natural disasters.
“It is very much in the interest of not only those countries but also of China as a local regional investor to keep this vital infrastructure protected. Even a mild earthquake in Kazakhstan or Uzbekistan could cause the transport corridor to be blocked.”
Savrassov added that the introduction of ILS does not have to be complicated: any country which has already borrowed money through Eurobonds is infrastructurally ready to issue cat bonds.
“It’s not rocket science,” he said. “From a technical point of view, issuance of cat bonds and issuance of borrowing bonds are absolutely the same, so already being on the international capital market for borrowing money through bond issuance means they can easily issue catastrophe bonds from a legal and infrastructure perspective.”
He agreed with Winand that a key factor will be a proper regulatory regime in the jurisdiction where these bonds are to be issued. Bermuda is still blacklisted in the majority of those regions as an offshore destination, but local players such as Singapore or Hong Kong—which has declared it wants to be an ILS player—could come to the fore.
“Either those regional centres need to become automatically acceptable by issuing countries or it’s a big task for Bermuda to get deeper into Europe and Eurasia and to change the status of the Island from being on the blacklist for all those counties,” he said.
An additional issue will be ensuring the cat models and data available for those geographies are of a good enough quality for investors to be comfortable with the risks. Savrassov noted that while there is a significant amount of excellent quality data, much of it is government-owned and classified.
“It’s a very big task for our modelling colleagues to work out a model that will be known and accepted by the investors,” he said. “However, I do hope that with input of the available data, a good working model can be achieved quite speedily.”
He added that the timeline for bringing ILS to these new geographies has shortened as a result of the impact of COVID-19.
“I believe that in three to five years’ time there will be an issuance of a cat bond by one of those countries and then it will have a domino effect. From the moment the first former Soviet Union country issues a cat bond, there will be a queue of its neighbours wanting to do the same.
“There is a very good route for growing up ILS activity and ILS business because you are not reinventing the wheel,” he added. “All you need is to follow the brilliant example of the ILS community which has been performing well for the last 15 to 20 years.”
ILS in other lines of business
Discussing lines that offer potential for ILS, Winand highlighted cyber, for which traditional insurance has been focused on cost avoidance, delivering support, forensics, preparation and recovery.
“When you start to bring it out of that bubble of cost avoidance to lines which are operational risks—and cyber is very much an operational risk—the numbers become huge, and north of anything anybody had done in insurance per se; you get to the billions immediately for a business of size,” he said.
“You then need to think of the risk transfer in a very different way and it needs to be more dynamic. Hurricanes, typhoons and winter storms, for example, are seasonal—they don’t turn up every day.
“In cyber space you can have a ‘hurricane’ happening all day long every day, so the question is, ‘how do you satisfy the buyer, the seller and the broker?’.”
Winand noted that while in the physical world it’s fairly straightforward to agree on a trigger that will lead to a payout, in the cyber sphere there is not an equivalent.
“People say there is no data on cyber but in fact it is quite the opposite—we are all drinking from a hosepipe, there are so many datasets out there,” he said.
He added that the key will be to come up with a measure of an economic loss. While cyber is not there yet, progress is being made and will likely hinge on having indices of economic performance.
“It’s about being able to state the value of risk. It’s not a matter of saying ‘Did something happen? Here is some money for ransomware’, but saying, ‘Something happened—how meaningful was it economically?’.
“And on the other side the investors who already own the risks have to be recompensed for those risks.”
Discussing other non-cat risks that may come into the ILS fold, Winand said that while there are some very attractive lines of business that offer the opportunity to bring in new investors, these investors will need to know what’s in it for them, and the total insurable value will need to be meaningful.
“It needs to have enough variability for those who are more on the trading end of the spectrum to come in—and they are not expecting to be locked up in something for 15 years,” he explained.
“They need to have a cash-to-cash inventory which allows them to roll their money a few times a year preferably.”
He highlighted trade credit, non-damage business interruption and parts of the mortgage business as attractive ILS prospects and predicted that ILS structures will become more dynamic.
“We see some products based around indices which allow different parties to readjust their risks, and more in real time; not 20 times a day but more than once a month you can readjust your portfolio risks,” he said.
Regarding the ongoing issue of trapped collateral, Savrassov said he expects some form of secondary trading of trapped collateral to develop, similar to live cat bond trading.
“All those bad things such as large catastrophe losses and the COVID-19 market crash work as a very good tuning mechanism which speeds up what could have happened anyway but could have taken a decade without this situation, and this sequence of losses,” he said.
Also looking to the future, Winand said that an exciting and vital part of the expansion of the ILS market will be the emergence of better developed models and indices to look after the new classes of business.
“The third party models are improving but there is some very exciting work in the cyber area, in the valuation of intangible assets,” he said.
“Once you are able to do that you have truly unlocked the box. The excitement for me is that ILS allows you to think of how you underwrite risk in a very different way and in a very scalable way.
“What is the third party dataset that allows you to trigger that shock absorber around the risks a business has? The innovation has just started to scratch the surface so it’s a very exciting place to be.”
To watch the full session on-demand on the Intelligent Insurer Reinsurance Lounge click here.
