Insurance, reinsurance companies and syndicates trading in the Lloyd’s of London market should leverage ILS capital and insurance-linked securities (ILS) as just one of a range of sources of capital, in order to secure their futures, according to Paul Culham, Group Chief Underwriting Officer at Tokio Marine Kiln.
In an article, Culham explains that the time to embrace ILS and alternative capital is now, for Lloyd’s players, as the capital source should just be considered another conventional backer of underwriting businesses.
Culham begins by explaining that Lloyd’s players are already actively using ILS capital, with a number of managing agents having launched what are essentially sidecar vehicles (often special purpose syndicates) funded by ILS capital.
While the use of third-party capital at Lloyd’s is not new and in fact Culham says working with ILS capital is taking Lloyd’s “back to its roots” these initiatives are also a “partial solution to the challenges of market conditions and London’s future.”
“This is the year that ILS vehicles will challenge traditional views about capital at Lloyd’s, and help the market to expand its horizons,” Culham states.
He goes on to explain the background of the ILS market and the fact that Lloyd’s underwriters can leverage the efficiency of the capital markets, to expand and augment their own pools of underwriting capacity, often at lower cost.
Culham then highlights the new regulations in the UK that allow for ILS vehicles to be structured and formed, domiciled locally instead of overseas, saying, “This creates the regulatory and supervisory framework necessary to develop ILS industries in the UK,” and that the regulations, “Create a significant opportunity for Lloyd’s to get back to a foundational skill: matching capital with risk.”
Lloyd’s has been a risk and capital matching market all of its history, but in recent years and perhaps driven by the rise of the corporate member, one eye has clearly shifted off the efficiency of the business models employed and the capital utilised.
Culham clearly believes that the new ILS regulations offer Lloyd’s an easier way to access the efficiency lever of ILS capital and expects companies operating there to take greater advantage of it.
“Through 2018 and beyond, with the new rules at their back, managing agencies are likely to become more focussed on packaging divergent risks to suit different investors, and better at it, too. In this way, leading companies will find ILS a flexible alternative to class-based and whole-account reinsurance,” he explained.
“Lloyd’s is central to the development of this industry in allowing access to a variety of investors with variable appetites and expectations, and developing the flexibility to match capital providers with portfolios of risk that suit them, enabling us to price risk more competitively,” he continued.
As a capital lever for efficiency, having access to pools of alternative capital can help Lloyd’s underwriters to better distribute their risks, matching them with the most appropriate capital, while also controlling their own exposures, peak and tail risks.
Culham said, “It was an important skill when all Lloyd’s investors were Names, and it is the way we must work now, to keep pace with the evolution of insurance investment.”
This is entirely the case and has been for a number of years, as Lloyd’s has been slow to become more open to ILS capital. But now the market has been through such significant losses and not had the huge rate increases it was hoping for, companies seem increasingly keen to understand how they can better and more effectively bring new capital within their structures.
Culham said that he believes 2017 disproved the theory that ILS is “hot money” giving confidence that the capital is here to stay.
“ILS markets perhaps reloaded even faster than conventional reinsurers, and improved their rates,” a point often overlooked.
While, “Talk of ‘trapped capital’ barricading the business clammed up quickly,” demonstrating that, “ILS investors are sophisticated, and haven’t missed the fact that catastrophes could wipe out their capital.”
While there are factors that could cause the amount of ILS capital available to ebb and flow, more larger losses, significant changes in interest rates, Culham feels the capital is here to stay and can be relied upon as a capacity provider for those operating at Lloyd’s.
“The diversifying nature of insurance risk will always remain as an offset. And after ILS investors’ quick re-load, they may adjust their return expectations upwards, to drive market conditions the same way. They are not immune to caution,” he explained.
Finally, Culham said that insurance-linked securities (ILS) and alternative capital is “rapidly becoming another variety of conventional capital” and that the London market and Lloyd’s should embrace it.
“Deploying capacity from a mix of sources – whether ILS funds, reinsurers, trade partners, shareholders, or traditional Names, whilst excelling at portfolio creation is likely to be a winning strategy. These factors unite in a new skill base: to marry internal capital modelling with the risk-return appetite of ILS funds, and package risk accordingly. If we all do that well, we can build on our market’s strengths, and secure our profitable future,” Culham closed.
Of course we couldn’t agree more. It’s taken a long time for traditional players in London to think of ILS capital as anything more than a source of reinsurance and retrocession, often viewed as lower-cost.
We’ve now seen the first use of the new UK ILS regulations by Neon, with more said to be in the works by market sources. We understand a number of Lloyd’s players are exploring how ILS fits within both their reinsurance and their capital structures, meaning further developments are expected this year.
If traditional players can see it for what it is, an efficient and fast-moving augmentation to their own underwriting capacity, available to help them grow sustainably, while managing their risk curves, then greater success and longevity is likely to be assured for many of those embracing the ILS market.
Leveraging ILS and alternative capital cannot guarantee a Lloyd’s players future. But it can help the firm to move forwards with added efficiency and growth potential, while establishing the best way to get paid for their expertise and intellectual capital, by becoming more open to new capital sources and structures.
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