In this the first of a new series of interviews with key industry figures, Artemis talks to Barney Schauble of Nephila Capital. Mr. Schauble has been involved in the weather risk market and in the securitization of insurance risks for many years and is highly regarded within both sectors. We spoke to Barney on a number of topics and his frank and full answers are below which we hope you enjoy.
How do you think the cat bond market is fairing currently?
Fine – it is a useful market for certain buyers of reinsurance to augment their capacity by accessing investors who buy securities. We are always happy to see more issuance, but the larger story is that private transactions with capital markets investors are growing, in number and size, more rapidly than the bond market each year and we would expect that to continue to be the case in the future. The bond structure remains a relatively high-friction way to buy protection.
How do you see the investor landscape changing?
Investors recognize the portfolio benefits of a presence in the asset class, but most are unable or uninterested in evaluating specific transactions or bonds, so prefer to hire a professional manager to assemble a portfolio of catastrophe risks on their behalf.
What do you think needs to happen to encourage more investors and institutional capital to the market?
Capital providers have been migrating steadily to direct (bond or collateralized reinsurance) participation in the market and away from indirect (equity – public or private – and debt) support of these risks. Every year there are more pension funds, life insurers, endowments, and other large capital allocators entering this market globally. The rationale is clear, but the process takes time and these are investors who demand real analytical and operational depth and expertise.
What do you think will help to encourage new issuers to ILS? At the moment the majority of transactions are issued by the same longstanding market participants.
For ILS issuance to make sense for a re/insurer or corporate, the size ($100mm+) and risk level (1% expected loss) have to meet very specific hurdles – there is a hallway through which cat risk can pass to the capital markets in the form of a bond, but that hallway has a series of large heavy and complex doors through which the transaction must pass. A small or medium-size insurer or factory with specific coverage needs less than $100mm, or riskier than 1%, or without ability to pay a banker, modeling agency, rating agency, and law firm is not going to issue ILS. However, more and more it may purchase collateralized coverage from a provider whose capital originates with an investor portfolio rather than with some distant shareholder.
What do you see as the attractive features of ILS for investors and issuers?
ILS still lack a standard structure – triggers, collateral, term, coupon all vary deal-by-deal. However, they offer some liquidity in a secondary trading market, unlike a direct reinsurance transaction. That liquidity can be an advantage for investors, but does not really matter to issuers. Issuers are attracted by the collateralization – which is worth more than any promise to pay – and by the access to additional capacity beyond the existing reinsurance market.
How do you see the market developing?
We hope to see more shelf and standardized issuance, and we expect that securitized issues may decline as a percentage of the total amount of capital markets involvement in catastrophe reinsurance.
Where do you see the ILS market going in terms of innovation? What innovations excite you?
Trigger structures that offer more transparency and granularity (LAZR, PERILS) help to build a more effective bridge between risk originators (re/insurance companies) and ultimate peak risk takers (investors).
Any fears for the markets future?
Poor behavior – fraud, elaborate and opaque structures, collateral that meets the letter but not the spirit of the arrangement – has had a negative impact on other developing markets and we hope that this market can steer clear of such issues in the future.
Any thoughts on regulation with particular reference to Solvency II?
Regulation that requires more explicit linking of capital to risk seems likely to result in a more vibrant market for risk transfer, in that risk will seek its most efficient ultimate home within a larger portfolio. Regulation that separates capital (or pricing) from risk, as has been the case in some insurance markets, is a short-term threat to development of these markets but a much more serious threat to the financial stability of those markets over time when losses inevitably arise.
What trends do you see emerging both in issuance and as an asset class?
A higher level of sophistication, transparency, and customization for investor portfolios – more focus on risk and return and less on form of investment contract.
What is Nephila Capital’s strategy regarding ILS and do you see that evolving going forwards?
Our strategy has been the same since the company was founded and started investing in 1998. Frank and Greg believed that this market made sense both for buyers of protection and for investors seeking a non-correlated yield, and that over time people with knowledge of the complexities and idiosyncrasies of reinsurance could serve as managers of capital at that intersection. We remain firmly of that belief, and try to keep the business simple and logical along those lines.
You’ve recently branched out into Australia with the Palmetto fund, are you looking at doing similar things elsewhere?
Catastrophe risk markets and alternative investment markets are global, and part of our rationale for entering into a strategic partnership with one of the premier global asset management firms (Man Group, EMG.L) was to expand our global reach. The Australian unit trust is one example of many where we have developed a specific structure to increase ease of institutional access to the asset class.
Nephila Capital are also involved in weather risk instruments. How do you see that market evolving?
The weather market is extremely small – we guess it to be roughly 1% of the size of the total cat market or $2bn in limits relative to $200bn in round numbers. We believe that logically it should be a larger market than catastrophe risk but at the moment business and individuals are rarely aware that tailored, large-scale coverage is available. We are doing our best to encourage market-leading intermediaries (WeatherBill) and strategic partners (Allianz) to develop that market with their clients, and we can take a similar role as we do in catastrophe markets which is managing capital to hold the ultimate risk
Weather risk deals are down on previous years, do you think the market has stagnated or rather volumes are more hidden than before as it is mostly exchange traded?
Unfortunately the weather market was born as a trading market, at energy trading firms and banks, and volume measurements focus on exchange-traded standardized contracts. Most companies exposed to weather have very specific exposures that are not well addressed by these instruments. There is a small market for these more direct transactions, but it is not clear that market is growing as rapidly as anyone would like. We feel that this is an origination challenge, and the size of the revenue (brokerage) opportunity suggests that that space will be filled by people with that expertise and infrastructure at some point.
Do you have any thoughts on what the next big thing in ILS or weather risk could be?
We do – we are always thinking about what the next logical step might be in how these business develop, and researching these ideas. To the extent they are good ideas and worthy of execution, we hope to read about them on Artemis in the future.
Any final words for the Artemis.bm audience?
Bill Gates once reflected something along the lines of “people typically overestimate what will happen in 5 years and underestimate what will happen in 10 years.” That was certainly true for those of us out talking about ILS and capital markets involvement in the early 1990s, and it seems safe to assume that remains the case today.End
Our sincere thanks to Barney for his time and the detail he put into answering our questions!
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