Aggregate ILS deals need improved loss information disclosure: SIFMA speakers

Investors in the insurance-linked securities (ILS) space would benefit from improved, and more timely, disclosure of loss information relating to aggregate reinsurance transactions, according to speakers at SIFMA.

The participation in catastrophe bonds, collateralized reinsurance, and private ILS contracts entered into by ILS investment managers that utilise an aggregate trigger, highlights the potential for ILS funds and investors to become increasingly exposed to frequency events.

A trend that raises the importance of investors and ILS fund managers receiving timely disclosure of loss information throughout any given contract term entered into, according to speakers at the 2016 IRLS SIFMA event held in New York recently.

In a traditional reinsurance contract, explained Michael Groll, Partner, Wilkie Farr & Gallagher LLP, the cedent informs the reinsurers’ of any losses to enable them to adjust reserves taking potential losses into account, helping to determine whether to renew the reinsurance agreement in the future and decide on future rates.

However, “the ILS bond market is very different. Given its tradable market for cat bonds versus other types of insurance risk, there is a need for the reinsurance industry to adhere to more timely information requirements compared to the traditional reinsurance markets,” explained Groll.

Stressing that as the traditional 144A cat bond market has evolved, and many more transactions utilise an indemnity feature, “there has been a greater need for real-time disclosure to investors, with regard to losses that count towards the aggregate trigger,” said Groll.

Groll raises a very interesting and important point. ILS transactions that trigger based on an aggregation of losses are a common feature of the ILS space; of the $7.841 billion of cat bond issuance witnessed during 2015 44%, or $3.2 billion of the deals that Artemis had data for were structured as an aggregate deal.

Again, this is just catastrophe bonds, so doesn’t include the wealth of collateralized reinsurance and private, or other ILS contracts that capital markets investors participate in, suggesting the amount of capacity exposed to an aggregation of losses is likely substantially higher.

Furthermore, collateralized reinsurance typically sits lower down a reinsurance tower than a cat bond, so third-party investors in these types of agreements are likely at even more risk from an aggregation of losses than cat bond investors, further highlighting the need for greater loss disclosure throughout the duration of the contract.

“I think that generally the most pressing thing that we see in terms of transparency or standardisation really lies in the context of providing additional disclosure to cat bond investors, that is of a similar nature to what is provided to the reinsurers,” said John DeCaro, Founding Principal and portfolio Manager at Elementum Advisors.

Adding; “The one point I would raise, where we very much would like to see the additional loss reporting, on a reasonably timely basis with respect to aggregate transactions, that would be fairly beneficial for us.”

Expressing the same view as Groll, DeCaro underlines the benefit and need for greater loss information to be divulged from ILS sponsors, especially with aggregate deals, stressing that while the structures of cat bonds are often matched with the same terms and conditions as traditional reinsurance placements, “we are still at a disadvantage in terms of the disclosure of actual exposures that can help us underwrite the bond.”

Part of the trouble is that public company sponsors of ILS transactions aren’t obliged to inform investors of loss details that aren’t publicly known, or loss information to anyone that isn’t required as part of the underlying document, explained Groll.

Furthermore, as losses mount throughout a year it might also be in the interest of the sponsor not to inform investors of an aggregation of losses that could result in a loss of all, or part of their investment, as it could result in a wave of investors looking to sell their investment and not return in the future.

It’s an important issue raised by both DeCaro and Groll. Increased, timely loss information disclosure for ILS investors would further support the evolution and growing maturity of the asset class, as the more transparent an asset class the more comfortable investors will be participating in it.

Additionally, with catastrophe bonds having an active secondary market, where notes can be bought and sold during the life-time of a deal, disclosure of aggregate losses is essential to ensure accurate valuation of the notes.

The last thing an investor wants is to buy a cat bond in the secondary market just before a new aggregate loss report is released, but after the event actually occurred, as they would not have a clear view of the risk of the trigger being reached.

Of course disclosure of losses does have an element of best-effort to it, in that an insurance or reinsurance sponsor of an ILS transaction can only disclose what they know. The key is in that disclosure being regular and there being a level playing field between traditional reinsurance arrangements and ILS or cat bonds.

It would also serve to mitigate any nasty surprises towards the end of an ILS agreement, as investors could be unaware just how close they are to losing their investment when disaster strikes in the final months, as they aren’t sure how much of the sponsors reinsurance programme has already disappeared due to the aggregation of losses from previous events.

This was seen in December 2015, when weather and catastrophe events raised some uncertainty about a number of collateralised reinsurance positions and the aggregation of losses under the contracts involved.

The ILS market is very good at working out these potential issues and putting in place processes to enhance disclosure and transparency. By working closely with sponsors, investors and others in the issuance process, the disclosure of aggregate loss information can surely be improved and made more timely, ultimately benefiting the entire market.