In a recent interview with Artemis, Michael Hamer of Albourne Partners discussed the importance of standardised reporting in insurance-linked securities (ILS) or insurance linked investments and the development of the Insurance Open Protocol Template.
Michael Hamer is a Partner and Senior Analyst at Albourne Partners in Bermuda, which is part of the Insurance Open Protocol Working Group.
We discussed the need for standardised reporting in insurance-linked securities (ILS) and reinsurance linked investments, as well the reasoning behind the development of the Open Protocol for insurance, and how this has been received by the market, so far.
Can you explain the importance of standardised reporting in ILS and reinsurance linked investments?
A quick review of current reporting by insurance fund managers will show modest similarities, but differences in detail or definitions in many cases make comparison and aggregation difficult or even impossible. The Insurance Open Protocol Working Group was set up to produce a reporting Template that addresses these issues.
We believe investors need to be able to make meaningful comparisons of activities and risks of funds over time, and increasingly need to be able to understand the aggregated risk exposures they may have from a portfolio of insurance funds. We also hope managers will welcome this because they will benefit from more informed investors.
The Working Group expects the Template to be a “living document” that will evolve over time. This first iteration focuses mainly on Property Catastrophe risk as this is the predominant insurance risk in fund assets under management, but the Template should evolve to more fully cover other types of risk, such as Life and Specialty and even Casualty, as these develop.
The Template and related Manual are available for review and comment by download from www.theopenprotocol.org. It’s a large template with a lot of data entries, but it includes three levels, or “Grades”, at which data can be reported. In the first instance, we are looking for reporting at the Grade 1 level (the lowest resolution), although we hope to get higher resolution reporting over time.
I’d like to suggest that managers, investors and other interested parties approach the review of the proposed Template and Manual in four steps:
(1) Are the broad areas, set out as separate worksheets in the Template, appropriate and complete; (2) Within each worksheet, have we captured the appropriate quantities at the Grade 1 reporting level; (3) For higher definition reporting (Grades 2 and 3) are the quantities and format appropriate?; and (4) Are the descriptions in the Manual clear, or is more guidance necessary?
What does the Open Protocol for insurance propose?
The Insurance Open Protocol Template builds on the Open Protocol template for general hedge funds that already exists. Like the general template, it asks for information on risks in five main areas: Leverage, Concentrations, Liquidity, Volatility and Tail Risk. However, insurance funds and particularly ones exposed to Property Catastrophe risk present unique challenges, which is why we have developed a separate Insurance template.
One important difference is that return history in most hedge fund strategies can be a useful source of information on risk levels and potential future performance, but for property catastrophe funds it is much less informative because the main source of downside risk, large event losses, occur infrequently. Nevertheless, useful information can be gained from a more detailed breakdown of the components of reported returns, showing the contribution of trading income from catastrophe bonds and the sources and patterns of losses, income and other adjustments to valuations over time.
We capture insurance exposures, but modelling of exposures in theory can provide better information on risk. In practice, modelling is subject to manager-specific modifications of data input and of the models themselves, and the output of modelling is often presented in a form that is hard to aggregate across funds. We propose the use of modelled loss estimates for a set of historical events as a compromise between full modelling and enough information that can be aggregated across funds.
In other strategies, side-pockets are often an admission of failure, but in insurance they are a useful tool to manage valuation uncertainty from large events within an open-ended fund. Their use results in different investors in the same fund having differing exposures, so we have asked for separate reporting of the main fund and each side-pocket.
The use of collateral to secure obligations and related issues of collateral release and contingent liabilities are also important, and the Template seeks information on assets in trusts and the potential for “trapped” collateral.
“Fronting”, where a rated and regulated insurer or reinsurer writes business which is passed on to a fund, is a vital means of access to markets or structures that insurance funds cannot access by themselves. It may also be combined with the provision of a “tail hedge” for the risks transferred. Such arrangements can impact the economics and risks of the fund, and introduce business and counterparty risk, and so we track this activity in various parts of the Template.
More generally, we have made reporting consistent with the existing general Open Protocol Template where possible, but have organized the Insurance Template into worksheets, which we hope make the intention of the data gathering clear.
What has feedback been like from end-investors?
Very positive. We know from discussions with our clients that there is a growing desire and need for better risk information at a portfolio level and at the fund level, to enable better performance comparisons and risk monitoring.
However, the information in the Open Protocol reporting is not the end of the story. Investors and their advisors, and other users of the data, will want to build systems that combine the Open Protocol data with qualitative and quantitative input from other sources to produce actionable risk information. Open Protocol data is often the input for “alerts” prompting more detailed discussions with a manager.
What has feedback been like from ILS fund managers?
Quite positive. Most managers realize there will be some systems work required to produce the reports, but they have generally expressed support the initiative as they recognize the current variety of reporting is confusing for investors, and requires considerable effort to compare and understand. Increasingly, larger sophisticated institutional investors are requiring customized reporting from managers, and we hope Insurance Open Protocol will meet many of these investors’ needs, leading to reduction in work for Managers.
Do you think a reporting standard could help to generate further ILS growth and perhaps attract more investors to the asset class?
Yes, for the reasons above, and the ability it will provide investors to monitor aggregations of risk in portfolios of insurance-linked hedge funds. All moves to make the asset class more transparent should to be welcomed, particularly if they also result in a reduction in effort by all concerned.