Lack of predictive modelling a factor limiting ILS casualty growth

A catalyst for the growth of insurance-linked securities (ILS) in the property catastrophe reinsurance sector is the capabilities of third-party modelling, but a lack of predictive modelling within the casualty arena mitigates entry and impact of a similar scale, according to industry experts.

The entry of alternative capital in the global reinsurance market has largely focused on well-modelled, existing product lines, most notably property catastrophe risks, serving to drive down rates and drive up competition at a time when investment returns are low and losses are benign.

On the back of this, insurance, reinsurance and ILS market commentary has, in recent times, discussed the potential drivers and limitations to the wealth of alternative reinsurance capital accessing casualty risks.

“Not at the moment,” said James Vickers, Chairman of Willis Re and panelist at the recent A.M. Best 2015 Insurance Market Briefing, Europe, held in London, when asked his thoughts on whether ILS was likely to make inroads into the casualty landscape.

“I think the issue around casualty, at least for ILS investors is the modelling. One of the things that helped trigger the ILS market was catastrophe modelling giving some sort of external third-party view of the risk, we’re miles off that in the casualty field,” continued Vickers.

A lack of historical, meaningful data, sparse technological capabilities and the typically longer duration of casualty exposures, especially when compared to property catastrophe risks, is a key reason the glut of alternative reinsurance capital has mainly focused on developed business lines.

And while the lack of models is apparent and clearly mitigates the expansion of ILS in the casualty space, Vickers underlines the retrospective nature of casualty business as a particular issue with casualty models.

“Casualty rating and pricing practice is always retroactive, there are very, very few, if not none, predictive models out there at the moment, and that’s an issue I think,” said Vickers.

The typically, longer duration of casualty exposures clearly creates difficulties when attempting to gain a predictive view of the risk, and as a result Vickers feels that even the tail-risk of casualty isn’t properly modelled.

Furthermore, Niklas Hilti, Head of Insurance-Linked Strategies at Credit Suisse Asset Management and fellow panelist, highlighted that the inherent longer duration of casualty risks presents its own barriers to ILS investors perhaps considering entering the casualty arena.

“I personally think casualty is definitely a long duration investment, and our experience is that long duration also requires very high returns, and I’m not so sure whether investors see those returns in the casualty market, at least today,” explained Hilti.

It’s a valid point, and further underlines the need for improved, comprehensive and predictive modelling within the casualty sector, providing ILS investors with a more holistic view of the risks, which should result in more adequate, sustainable pricing.

Vickers continues to note that during the last decade, at least on paper, casualty results have been fairly excellent, but hastens to add that it’s unclear whether this is just that those that operate in the space have been lucky in recent years, or owing to a primary shift in societies view on casualty risks and amendments to legal systems, for example.

While he agrees with Vickers, Matthew Mosher, Senior Vice President, Global Rating Services at A.M. Best, suggested that it could be the fact that modelling is so good on the property side, that there’s a lack of models in the casualty space.

Mosher explains; “I think it’s almost an overdependence on models in some cases on the property side. In terms of wait until the next event, and how the models come out. I mean look at the history where models miss and what their reinsurers and insures have done, and what’s changed with the modelling companies.”

Leading Vickers to add that although he wouldn’t disagree with the notion of an overdependence on models in the property catastrophe landscape. “But that at least they are forward-looking; they are trying to look forward.”

As reinsurance companies and ILS participants look to offset the challenging property catastrophe environment, the entry into less pressured business lines, like casualty is expected to grow.

But it’s unlikely that ILS will make any meaningful impact or inroads anytime soon, according to some industry experts.

However, the enhancement of casualty exposure modelling and the understanding of the risks will only evolve in the future, meaning that it’s likely a matter of when, and not if, ILS broadens it reach and begins to enter the casualty space with some significance.

Also read:

– Big data liability catastrophe models to help ILS into casualty risks.