At German reinsurance firm Munich Re’s annual Monte Carlo insurance-linked securities (ILS) roundtable event yesterday, first time sponsors of catastrophe bonds and other ILS market experts discussed some of the pro’s and con’s cedents encounter.
The annual event was extremely well attended, showing the continued interest and appetite to learn and hear more about ILS from Monte Carlo Rendez-vous participants in 2014.
The panel featured two first time sponsors, who’s first cat bonds came to market within the last year and they were asked to talk about their experiences, as the reinsurance buyers at large primary insurers, as well as to detail some of the positives and negatives of their cat bond sponsoring experiences.
Franco Urlini, responsible for reinsurance buying at huge primary European insurer Generali, said that it was a “convergence of terms” as well as attractive pricing which made it the right time for the insurer to issue its first cat bond Lion I Re Ltd. this year. The insurer wanted to issue a cat bond as a way to further diversify its sources of risk capital and reduce its reliance on traditional reinsurers alone, which with such a large programme is a sensible move.
Urlini discussed the “difficult process” that is issuing a cat bond for the first time, saying that it took much more time than renewing the firms catastrophe reinsurance programme. Reasons for the length of time taken to get to issuance included the education process for the Italian regulator, as Generali was the first Italian insurance company to become a cat bond sponsor.
Jim Fiore, in charge of reinsurance buying for Australian insurer QBE, also said the insurers first cat bond, VenTerra Re Ltd. (Series 2013-1) issued last December, took much longer than the firm expected. QBE wanted to sponsor a cat bond as a way to augment traditional capacity that was not always easily, or cost-effectively, available in the traditional market, as well as price which was also a key factor. However, regulator discussions alone took a year for QBE, he estimated, while the entire process was perhaps as long as a year and a half.
Other complexities such as the fact that VenTerra included both Australian and U.S. perils, which meant that the currencies were different and so had to be converted, also helped to extend the process for the insurer, Fiore said.
The legal overhead was a theme that both first time sponsors discussed, Fiore saying that a cat bond has much more legal paperwork to deal with than traditional reinsurance. Urlini agreed, saying that the burden of legal paperwork is significantly heavier.
On the positive side looking forwards, Michael Madigan a partner at law firm Sidley Austin, said that he hoped that the market would reach its long-held goal of standardised documentation by 2020, when asked what he saw for the future of the ILS space. He also noted that the rigour of disclosure in catastrophe bond documentation is a good thing, as it helps when a bond is triggered by reducing the chance for ambiguity.
Fiore explained that the attraction for QBE was the fully-collateralized nature of a catastrophe bond as well as the multi-year nature, features which are important to all sponsors of the bonds. The amount of work required was a surprise, as the burden was much larger than expected, but the panel discussed the fact that this does get easier on second and subsequent issues for sponsors.
Urlini added that sponsoring a catastrophe bond is more complex, takes more time and there is more to disclose than in a traditional reinsurance deal, all things which add time and work for the sponsors. On the plus side he said that so many departments at Generali were involved in the issue that the company had much more awareness of what was being purchased than when it buys normal reinsurance. He added that it also helps that the same team that purchase the reinsurance at Generali sourced the cat bond cover as well, ensuring that no gaps are left due to a lack of reinstatements or any other differences between the two.
Fiore went on to discuss the cost of sponsoring a cat bond, saying that the amount of expenses involved were a surprise, particularly as they are typically all paid up front. Urlini said that at Generali they carefully compared the all-in costs of cat bond sponsorship versus reinsurance cover and also how much the reinsurance would be in years two and three of the cat bond. The cost comparison clearly came out favourably as the insurer brought its first cat bond to market.
The panelists were asked whether index-based cat bond transactions might be dead and whether we would see indemnity triggers increasingly the structure of choice.
Jonathan Barnes of ILS manager Securis Investment Partners said that indemnity transactions can be onerous for the sponsor, reflected in the experience of the two first-time sponsors on the panel. However, indemnity is a better fit for these primary insurers as it most closely resembles their risks and although onerous the disclosure is worthwhile.
However, reinsurers still like index and parametric triggers, Barnes explained. Parametric triggers in particular are also very useful for providing protection for infrastructure type risks in emerging markets.
The basis risk inherent in index and parametric triggers was raised, with Munich Re board member Thomas Blunck saying that as a large, globally diverse reinsurer his firm can handle the basis risk in index cat bonds. Munich Re uses non-indemnity for its cat bond covers and Blunck said that as their portfolio is so complex the disclosure necessary for an indemnity deal would be very difficult to achieve.
Fiore of QBE said that the decision to do an indemnity cat bond came down to basis risk for the insurer, adding that QBE cannot accept that level of basis risk in its reinsurance cover, needing certainty over coverage, but that reinsurers can accept that risk in a different way.
For first-time sponsors these decisions and issues are key considerations, however in the case of QBE and Generali, as well as the many other new sponsors that have entered the cat bond market in the last twelve months, the experience was worth the perseverance and they are expected to leverage cat bonds as a portion of the reinsurance protection in future renewals.
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