The range of fully collateralised insurance-linked securities (ILS) mechanisms remain largely untested in the face of a large loss-event, and the complexity of extreme events suggests that potential tensions within the marketplace could emerge after an event, according to industry leaders.
Speaking as part of the Chief Executive Officer (CEO) panel at the 2016 PwC Bermuda and S&P Global Ratings conference at the meeting of the reinsurance industry in Bermuda, in November 2016, industry leaders discussed the expanding, but largely untested abundance of ILS capacity in the global risk transfer space.
It’s been discussed numerous times in the past, and in particular since alternative reinsurance capital starting to expand rapidly and reach an influential size, that the range of mechanisms and business models remain untested against a large loss-event.
While some in the industry predict a number of ILS funds and managers to leave the space when the next large event takes place, the majority of industry experts and observers believe that its uncorrelated and diversifying benefits suggests that existing institutional investors will return post-loss, and that many new capital markets investors will also look to enter the space to take advantage of changing market dynamics.
Kevin O’Donnell, President and CEO of RenaissanceRe Holdings Ltd., told the audience that the question is “not whether the capital, but whether the capital manager has been tested effectively.”
“It’s one thing just to have a collateral agreement and call the capital, it’s another thing to have an agreement that it’s yours. But I think there are tensions in the system that will emerge post-loss,” continued O’Donnell.
The fact that the wealth of ILS capacity, which now stands at a reported $75.1 billion, hasn’t experienced a large loss-event continues to drives questions about its permanence, ability to pay claims, and likelihood to dispute claims. The reality is that until a large event takes place and a substantial amount of traditional and alternative reinsurance capital is removed from the sector, it’s largely unclear how ILS players and capacity will react.
One such tension highlighted by O’Donnell concerns the roll forward of collateral without expiration of existing contracts, something that he explained was evident at the end of last year.
However, such issues and other uncertainties are the sorts of things that “will emerge over time,” said O’Donnell.
“I think there will be good players that will pay losses appropriately, and there’s likely to be a distribution of those that behave differently.
“I think all in all, the question is are the structures appropriate for the types of risk that we’re taking. I think generally, yes, but it is going to depend on how the losses emerge and how overtime they are settled,” continued O’Donnell.
O’Donnell also raised a very important point about the complexity of, and potential for certain risks to really challenge the collateral mechanism, something highlighted by the ongoing claims settlements from the 2011 Canterbury, New Zealand earthquakes.
“Losses can take much longer than people realise, and holding collateral and then stacking it with refunding into new vehicles, can take a toll on any investor.
“So I think it will be something that as there are losses we’ll begin to realise, there are elements of this that are more challenging than perhaps what we’re used to in the rated world,” explained O’Donnell.
Artemis discussed recently how IAG New Zealand had extended its reinsurance protection to help it pay claims from the 2011 Canterbury quakes, an event that highlights the inherent complexity with certain perils and the need for investors in the ILS space to understand and appreciate the potential for such things to occur.
Fellow panel speaker Keane Driscoll, CEO of Validus Re, also noted the complexities of certain exposures and how this can be a concern for some in the ILS space.
“The collateral mechanism is yet to be tested. It’s something that is a concern of mine, a concern of everyone in our organisation, both as a buyer and a seller. How that’s going to work, how that gets tested.
“We know when there are big events, they’re complex and they take much, much more time than anticipated. This concept that we’re a short-tail market, yes it’s short-tail, if there’s no event you get your money back,” said Driscoll.
However, when there is an event, and New Zealand is a great example, explains Driscoll, potential issues can arise.
“That (2011 Canterbury, New Zealand quakes) largely didn’t get locked up in the ILS space, but that’s the dynamic we’re dealing with. I don’t think investors entirely appreciate it, I don’t think they go away, some of them may, but I think broadly more money will come in.
“There’s definitely a lot of learning that needs to occur in the ILS space before it’s fully developed,” said Driscoll.
And that’s what’s important, that the ILS market learns from any tensions that do emerge post-loss, resolves any issues and adjusts structures to ensure these tensions do not occur again.