U.S. primary insurance company Allstate has been actively exploring ways to use more third-party reinsurance capital within its business, but to date hasn’t found a compelling way to leverage alternative reinsurance capital or ILS as a tool to help the business grow.
That was according to Mike Demetre, SVP and Chief Risk Officer at Allstate, who was speaking at the SIFMA Insurance and Risk Linked Securities (IRLS) 2015 conference held in New York last week.
Allstate already uses the capital markets for reinsurance protection through its Sanders Re series of catastrophe bond issues in recent years. With $950m sponsored in 2014 with Sanders Re Ltd. (Series 2014-1) and Sanders Re Ltd. (Series 2014-2), as well as another $350m in-force from the 2013 Sanders Re Ltd. (Series 2013-1), the insurer has demonstrated its liking for fully-collateralized coverage through cat bonds.
Speaking at the event Demetre explained what it is that Allstate likes about alternative capital and how it thinks about ILS, catastrophe bonds and other third-party capital structures.
As a protection buyer Demetre said “we look at this, all the reinsurance, cat bonds and others, and how it plays in our overall capital strategies.” The key concern that Allstate has is basis risk and how to minimise it within the ILS products it purchases.
Another key concern, that Allstate considers another form of basis risk, is ILS contracts two or three year commutation clauses. He said that there is concern that litigation could drag out for a significant amount of time after a loss and when the insurer looks at ILS it needs to consider how commutation will be handled and how the ultimate tail of the product and contract will look.
Another issue that Demetre mentioned is payment obligations and that ILS remains untested. On the other hand he also noted that ILS has the collateral ready for an insurer like Allstate to use after major catastrophe events, at times when perhaps traditional reinsurers may be struggling.
Transaction friction is another concern. He said “it sure would be nice to be easier” to enter into ILS and that if the industry really wants to grow then the ILS market needs to find ways to reduce the friction and make the transaction easier, while keeping costs comparable with traditional reinsurance options.
If you’re thinking about how to take a balance sheet and how to optimise the various risk tranches, ILS is very attractive, for us, given that we’re a stock company, that we’re a largely monoline U.S. wind carrier. It’s very attractive in the upper tranches of hurricane cat.
He said it would likely be different for other companies though, so it’s hard to define a sweet spot. He said that the ILS market is very good at bringing Allstate lots of different options to consider, which are all very interesting but Allstate needs to consider strategically how long the ILS trend is going to last and what happens when the yield curve goes back out.
From his perspective right now and as far as where Allstate’s risk transfer goes, Demetre said that where the insurer has played so far with ILS in its capital structure is the optimal place for it right now.
Demetre discussed what might make Allstate think again about using ILS and catastrophe bonds, or other alternative capital reinsurance structures. The first reason might be a massive catastrophe event that locks up collateral and causes some dislocation of the market or transactional friction, which he said could put Allstate and other insurers off the ILS space.
The second risk he sees is the permanence of ILS investor capital. Demetre said that there is still some concern over how much of the current ILS capital is permanent, seeking an asset class with low correlation for the longer-term, versus how much is still seeking yield.
When asked what might cause insurers like Allstate to double-down and use more ILS, Demetre said it would be the continued evolution of the market and what it accepts, how ILS embraces new risks and classes of business, how it addresses basis risk concerns and how it responds to sponsors needs.
If the market continues down its recent path of maturation and growth Demetre said that there would be more opportunities for those who generate risk to access new forms of capital and ILS, ultimately an “optimisation of laying off risk” using multiple sources of capital.
Demetre was asked whether there was something that might cause Allstate to think about leveraging ILS and alternative capital as a way for the insurer to grow. He commented that Allstate has been growing but that it pulled back from the coastal regions a few years ago and this would be the area that ILS would likely be most interested to support growth in.
However Demetre responded “I think it get’s down to a permanency of capital.” He said that Allstate needs to be more confident that ILS capital would be “absolutely permanent” in order to be a structure that the primary insurer could grow its business backed by.
He said that Allstate talks to a lot of people, looks at solutions that are proposed but “hasn’t found anything compelling to date.”
So Allstate looks set to continue to leverage ILS and catastrophe bonds for risk transfer, but as yet has not found a way to bring it more permanently into the insurers capital structure. Should it find the right way, a structure that allowed it to target growth backed be permanent third-party capital, it would be interesting to see just how aggressive it would be.
While ILS continues to provide a source of risk transfer that fits certain tranches of the insurers capital structure though, it does free up balance-sheet capital to put to other uses, including growth. So while no solution for permanent growth backed by ILS has been found, it is likely that the use of ILS and catastrophe bonds has helped the insurer to add incremental growth in recent years.
Should ILS managers and investors find a structure that works and a way to make their capital feel more permanent to major primary insurers like Allstate, all bets will be off on how that impacts the re/insurance market and we could see the next phase of significant disruption as a result of such innovation.