Aggregate ILS arrangements to see risk rising through 2017

by Artemis on May 22, 2017

Once again, the prospects for some aggregate reinsurance contracts, ILS deals and even some catastrophe bonds, in particular those which have exposure to U.S. severe thunderstorm risks, are being highlighted as gradually becoming more risky as deductibles are eroded, raising the risk that some could face losses later in the year.

Supercell and tornado severe convective weather2017 has seen a rapid and active start to U.S. tornado and severe convective weather activity, with insurance and reinsurance losses from this peril rising rapidly to over $5.7 billion in the first-quarter of the year alone, which is a new record for the first three months of the year.

We’ve seen this a number of times in recent years, as the aggregation of U.S. weather losses has caused deductible erosion and heightened the risk of some ILS investments in these reinsurance contracts.

2017 could see this become an issue again and it’s not just due to U.S. severe weather. There are regional and global aggregate contracts in the market, which means losses around the world can contribute to deductible erosion, keeping ILS fund managers on their toes as they calculate the potential risk to assets in their portfolios.

“Natural disasters in March had little direct impact to ILS funds so far, although some ILS funds said they are still monitoring potential loss from the tropical cyclone Debbie in Australia,” Stefan Kräuchi of ILS Advisers, who track the ILS fund market with their Index told Artemis recently.

While immediate impact from March’s severe weather and natural catastrophe activity is not apparent yet, it is the future potential impact to aggregate reinsurance contracts that could become significant for ILS funds and reinsurance investors as the year progresses.

As severe thunderstorm losses have risen across the United States, so have global disaster losses, reaching an estimated insurance industry loss total of near $10 billion in Q1 2017 alone.

This increases the potential for attrition to aggregate layers and risks to reinsurance contracts in other countries grow as a result, as this makes the triggering of these aggregate layers of reinsurance arrangements more probable as the year progresses, as the aggregate deductible and retention is steadily eroded.

ILS funds are expected to be quite exposed to this type of aggregate contract, particularly in collateralized reinsurance or private ILS arrangements. It’s also important to consider the potential for these attritional losses to hit quota share sidecars and reinsurance deals, although much harder to know when losses could reach a level that are passed on to investors in these vehicles and structures.

There are also catastrophe bonds which are exposed to this build-up of severe thunderstorm and convective weather related losses, such as the Skyline Re cat bond from Cincinnati Financial, which as we wrote recently is already under threat and its secondary pricing has been lowered as a result.

“Storm losses last year already exerted material impact on cat bonds, such as the partial payout of Gator Re,” Kräuchi explained.”Although no significant direct damage was seen to fund performances so far this year, the potential threat to the aggregate contracts still raises concern, which may be more obvious at the year end.”

In order for these reinsurance contracts and ILS deals to come under pressure later in the year, the run-rate of severe weather losses needs to continue.

So far the U.S. tornado season is running ahead of average, in terms of the number of tornado reports and so far through April and into May this shows no sign of slowing down.

Catastrophe losses are also mounting up at U.S. primary insurers, another sure sign that aggregate arrangements could become a concern later in the year, if frequent attritional weather and catastrophe activity continues.

With some of these aggregate contracts offering multi-peril coverage, the real deciding factor could be the U.S. tropical storm and hurricane season, as with deductibles eroded it may not take a major storm for losses to begin to erode the aggregates even further in 2017.

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