Australian terror pool rejects ILS & collateralised retro on price

The Australian Reinsurance Pool Corporation (ARPC) has rejected including any retrocessional reinsurance capital from ILS or collateralised markets in its recent $2.9 billion program renewal, as they price the risk above the traditional market.

The Australian Reinsurance Pool Corporation is a statutory authority which provides the terrorism reinsurance backstop for the Australian insurance market, ensuring that insurance cover for eligible terrorism losses remains available for commercial property and infrastructure, as well as for any associated business interruption losses and public liability.

The ARPC recently announced the completion of a $2.9 billion retrocession program renewal, at which it hailed the fact that it “reduced its retention to $350 million (from $400 million in 2015) and increased retrocession cover purchased to $2.9 billion (from $2.6 billion) for approximately the same dollar amount as the 2015 program.”

That is testament to the softened reinsurance market conditions and the appetite among global reinsurers to support large, property related, terror reinsurance and retrocession needs. These pools often command very keen pricing, as the risks are segregated to a degree and perhaps more easily modelled and understood.

The renewal also saw some relaxation of terms and conditions, with retrocessionaires participating agreeing that they would expand the cover to include mixed-use and high value residential buildings if the ARPC scheme was adjusted to cover such assets.

So with all the talk about insurance-linked securities (ILS), alternative capital, ILS funds and collateralised reinsurance being among the cheapest and most efficient, you’d be forgiven for thinking that there must at least be an element of it in the ARPC renewal. Wouldn’t you?

It turns out that there isn’t any ILS or collateralised reinsurance participation in the program at all, despite the fact that the ARPC met with ILS and collateralised players as it took its renewal program to meet the markets.

Michael Pennell, Chief Underwriting Officer, Australian Reinsurance Pool Corporation, told Artemis; “For our 2016 retrocession renewal program, none of our counterparties are collateralised or ILS fund players.”

For the 2016 program renewal the ARPC met with almost 60 reinsurers in key markets to negotiate pricing and terms and to secure the necessary cover. In recent years that has included meeting with ILS players.

Pennell explained; “Since 2014, ARPC has met with both collateralised reinsurers and ILS funds in Australia, Bermuda and the US to assess whether those products would be suitable for ARPC’s program.”

But interestingly the ILS and collateralised markets would not meet the pricing level required to gain signings on the ARPC retro program, with traditional reinsurers coming out cheapest.

“Our conclusion is while the capability of these companies to price reinsurance risk has greatly improved, collateralised and ILS markets are still pricing terrorism risk slightly above the traditional market. Therefore, they are not yet considered to be value for money,” Pennell said.

There are a number of possible reasons why ILS and collateralised reinsurance markets could not meet the keen pricing of traditional retrocessionaires. Firstly they don’t have the diversification of the major global reinsurance players, second terrorism is not a major peril for the ILS market and thirdly they may have felt the pricing is just too low.

With large global reinsurers having admitted to underwriting some lines of business at levels below cost-of-capital and reports from the January renewals suggesting that more discipline was seen on pricing in ILS markets than traditional, we perhaps shouldn’t be surprised that ILS has not participated in this renewal.

A number of ILS players are happy to write terror reinsurance and retrocession business, particularly that from a government organised pool. But in this case the pricing does not seem to have met the return hurdle requirements for these players, as they do have minimum returns to provide to their investors.

That’s another area where traditional reinsurers can have an edge on price, the fact that they are not as bound to generate a set return as the ILS fund managers, as well as their ability to discount lines further as diversifiers.

The ARPC will continue to investigate the ILS and collateralised markets though and it’s likely only a matter of time until some capital markets retrocessional capacity finds its way into the pool’s retrocession program.

The ARPC also expects that ILS and collateralised pricing will converge closer to traditional reinsurers in terrorism risks.

Of course, we’d suggest that this depends on just how much this risk is being discounted by traditional markets, as ILS players won’t discount for the sake of it just to win new business unless it meets their requirements as a diversifier, which currently it appears not to.

Pennell said; “Assuming financial markets remain subdued, we expect reinsurance price convergence to continue so ARPC will remain interested in a collateralised or ILS product in the foreseeable future.”

ILS and collateralised markets have often been accused of being the cheapest capacity, with some insinuating that it underprices risks. That’s clearly not the case here, or reportedly at the recent January renewals, as ILS markets demonstrate their discipline by refusing to bow to pricing pressure.