Optex index can enable trading on Lloyd’s market performance

by Artemis on July 28, 2016

With the expected mid-2016 launch of the Lloyd’s index from specialist insurance and reinsurance marketplace Lloyd’s of London being delayed, Optex, a risk transfer provider to the re/insurance and capital markets’, has highlighted the potential for market participants to utilise its own variant, Lloyd’s Lite.

News of the proposed Lloyd’s index was announced towards the end of last year, described by Lloyd’s of London as an index for diversified insurance risks that would be “based on detailed insight into the performance of the market,” featuring loss ratios and data on insurance market performance.

At the time, Lloyd’s said that it aims to launch the index in mid-2016, but according to reports from the industry this has now been delayed, although it remains unclear when the marketplace now plans to launch the index.

Until the Lloyd’s index comes to fruition, Andrew Martin, Chief Executive and a founder at Optex, which is a wholly owned subsidiary of long-established Lloyd’s brokerage entity Besso, has underlined the potential for market participants to utilise Lloyd’s Lite, the Optex variant.

Speaking to Artemis, Martin explained that Optex has produced its own Lloyd’s Lite variant since 2013, using the combined ratios published by Lloyd’s in its aggregate accounts, and which offers “a way to create over-the-counter bilateral trades to allow insurance longs and shorts to turn their views on the market – into positions.”

Bruce Paterson, a self-employed actuarial consultant in Toronto, Canada, collaborated on the project, producing all the actuarial work for the Optex variant, said Martin. Explaining that this really helped him to get a fix on the volatility, while also providing a way to benchmark pricing.

Martin explained that the combined ratios published by Lloyd’s “are sufficiently robust to be of use to market participants to either hedge or assume market risk.

“Optex have compiled the Lloyd’s data back to 2004 which shows results and trends for the accident year; the calendar year for the whole account, and the eight market sectors for which Lloyd’s produce the data,” continued Martin.

The longevity and scope of the specialist Lloyd’s of London market means it has access to a broad range of unique data, both current and historical, so it is well placed to offer a service that provides an index of diversified underwriting risk performance data.

But with the index now being delayed, Lloyd’s market participants and those outside of the space looking to get more involved, like insurance-linked securities (ILS) funds/managers, for example, remain unable to either hedge, or assume Lloyd’s market risk.

“Fund managers use index put and call options to hedge adverse movements in stock portfolios, as well as receive premium by writing options or lending stock – and hedge funds will borrow stock to short where they see arbitrage opportunities.

“Lloyd’s investors – whether private ‘Names’, or large corporate syndicates should have a means to hedge their market, and in a way that allows capital to be retired when not being used as collateral,” said Martin.

The global reach of Lloyd’s and its prominent position in the insurance and reinsurance landscape means it’s exposed to a wide range of catastrophes risks in various peril regions, exposures that Martin notes the marketplace can’t reserve for in advance.

As the Lloyd’s index would offer, the Optex Lloyd’s Lite variant could enable those within the marketplace to access capital market sources of retrocession and reinsurance for risk transfer, providing them with a means to hedge or secure long-term cover based on the occurrence of major events impacting the performance of the market.

Instruments such as industry loss warranties (ILW’s) could be constructed using Lloyd’s market performance data, providing valuable hedging tools, or the ability to access the return of the market.

“Every other capital market has an ability to either hedge or assume market risk and indices are the key to doing this. Insurance risk and Lloyd’s in particular is uncorrelated with other market or asset risk so the integrity and consistency of Lloyd’s published results is the ideal yardstick to use. Market participants taking long or short positions will help dampen cycles and attract new capital to an old industry,” said Martin.

According to Martin, that the Lloyd’s Lite alternative provides details of calendar year results is of great use to market participants that are looking to hedge market risk, as this will likely mirror their own experience and, it’s expected that they will understand how correlated they are to the Lloyd’s market.

In a presentation seen by Artemis, Optex explains that the advantage of an index, and trading a Lloyd’s calendar year combined ratio index enables market participants to hedge, and investors to access, insurance risk and rewards.

As a result, Optex feels there is an opportunity to establish reinsurance or derivative contracts to either hedge, or assume, Lloyd’s market risk, utilising the Lloyd’s Lite index.

On the buy side, “Lloyd’s businesses can hedge calendar year results,” while on the sell side “reinsurers or investors assume risk without complex reinsurance arrangements,” explains Optex.

Furthermore, “new counterparties can acquire pure insurance risk, participants can dynamically adjust exposure,” while “a traded market will ensure price discovery and forward trading will ‘turn views into positions’ and help dampen cycles,” continues Optex.

Such an index as the Lloyd’s Lite from Optex, and also the Lloyd’s index itself once it’s launched, has the potential to pull additional capital into the marketplace from both traditional and more alternative sources, while enabling market participants to reduce any wider market performance volatility, something that could be more prevalent in the softening re/insurance landscape.

Martin’s clearly feels that the Optex Lloyd’s Lite variant can provide a valuable service to those in the Lloyd’s market and those sat outside, perhaps waiting to enter, or unable to do so meaningfully owing to high barriers of entry.

“We await the promised Lloyd’s index with interest – no information has been forthcoming as to its proposed composition, nor what sort of contracts they envisage being traded.

“Obvious developments that would put Lloyd’s front and centre in this insurance nouvelle cuisine of the capital markets assuming insurance risk as non-indemnity contracts would be to create a trading platform with visibility of prices and open positions – and provide a clearing system. Transparency will engender liquidity and Lloyd’s would sit at the cross-roads of capital market/ insurance convergence,” said Martin.

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