Evolution of illiquid & liquid ILS to continue in 2017: Bill Dubinsky, WCMA

In this interview with Artemis Bill Dubinsky, Managing Director & Head of Insurance-linked securities (ILS) at Willis Capital Markets & Advisory (WCMA), described the benefits and challenges of illiquid and liquid ILS investments, citing trends witnessed in 2016 and what this might mean for the market in 2017.

The potential for ILS expansion into new business lines was also discussed, and Dubinsky underlined possible shortcomings of the sector that should be highlighted and addressed in the year ahead.

As ILS has expanded and its influence in the global insurance and reinsurance industry has increased, the pros and cons of illiquid versus liquid ILS investments has become of greater importance. What are your thoughts on this trend?

There are pros and cons of illiquid ILS vs. liquid ILS (cat bonds). If you use these more precise terms, it makes it easier to understand the trends. Illiquid ILS is simpler to arrange and at the same time results in ceding companies often paying higher premiums. This translates to a higher stated investment return representing an illiquidity premium. Obviously, the illiquidity is not just a benefit for investors but also a cost when they do need liquidity to either manage redemptions or rebalance their portfolio to take advantage of other opportunities. In effect, investors in illiquid ILS are managing not only the linked insurance risk but also heightened liquidity risk. Liquid ILS on the other hand accesses a broad range of institutional investors and without these risks, and, partially as a consequence of less liquidity risk, often pays a lower return.

The relative balance between the two forms of ILS is simply dictated by supply and demand forces. In the first half of 2016, these seemed to be pushing more towards the illiquid form and in Q4 things have swung back strongly the other way. In 2017 and beyond, some of the key factors that will drive things in either direction are investors demand for increasing liquidity and further simplification of the liquid ILS process, as well as the emergence of ILS with characteristics of both liquid and illiquid ILS.

In some ways the breakdown between liquid and illiquid ILS is the most important question for industry insiders to understand. Yet, we believe the prognosis for 2017 is far from clear. While the ILS market as a whole will continue to grow, the precise shape on this dimension is less clear. For ceding companies, given the overall growth and availability of ILS capital, the relative balance between the various forms of ILS matters much less.

Are there any trends that you expect to see develop further in the ILS space over the coming months?

The integration of ILS capacity with other sources of capacity will continue, especially for established risks like property catastrophe. Reinsurance intermediaries continue to improve at developing reinsurance programs that skilfully integrate the different products and the different sources of capacity to efficiently achieve specific risk management objectives. Organizations with a “product push” mentality and only one or two tools at their disposal may continue to struggle.

Any new lines of business or continued expansion into new lines you expect to see?

We expect gradual expansion into lines beyond property cat to continue in 2017. Generali’s Horse I DAC transaction is one example. Achieving this requires fundamental change to existing practices as well as innovation. Sometimes this may involve solving entirely new problems. The key question is less ‘Is an ILS structure possible as a technical matter?’ because the answer is almost always yes. Instead, the question is whether there is a commercially feasible solution to reasonably important problems where traditional capacity is insufficient on its own.

It is possible for ILS capacity to help support an entirely new risk transfer market provided the economics “make sense” and the rationale for new product innovation is abundantly clear to ILS investors. Still, breaking new ground is less likely to succeed than helping grow an emergent, or even better, established insurance or reinsurance market.

As 2017 gets underway, are there any issues you feel the market should really work to address?

Negative yields for stable value yen and euro investments present an obstacle at the margin for ceding companies using these currencies to access ILS capacity. Reinsurers face similar issues as ILS investors but have flexibility in managing duration and asset mix. In contrast U.S. ERISA rules and end investor preferences severely limit flexibility for ILS investors. While these limits may serve a valid purpose for the most part, in the prevailing rate environment they dampen the potential volume of yen and euro-denominated transactions. Even if the current impact is relatively slight, it is nonetheless important for the market to address because it has the potential to become a greater problem if the rate environment deteriorates further for the yen or the euro or if other currencies are similarly impacted in the future.