Around 15% of ILS funds have COVID BI loss reserves of over 4%

Some higher-risk insurance-linked securities (ILS) and collateralised reinsurance funds have been forced to reserve more than 4% of their fund assets in case of losses from business interruption claims caused by the COVID-19 pandemic, a report suggests.

For the ILS fund market, the main exposure to losses from the pandemic is through business interruption claims against commercial property policies.

While the global insurance and reinsurance market faces claims from the spread of the coronavirus across many lines of business, the ILS fund market’s focus on largely property catastrophe risks means the overall impacts will be relatively limited considering the pandemic’s impacts.

For the global traditional insurance and reinsurance market, publicly reported COVID-19 pandemic-related losses, IBNR reserves and estimates have now reached some $24.7 billion including third-quarter results disclosures to date.

For the ILS market the impacts are largely in the form of reserves so far, with actual claims seen as relatively minimal to-date.

But as we explained last week, there are concerns that reserves and as a result trapped ILS capital may be forced to rise if the global waves of pandemic lockdowns persist for longer than anticipated.

But just how impactful COVID has been to ILS funds is harder to derive, as information is scarce on actual ILS fund side pocketing actions and losses.

Which makes the reporting of roughly how many funds have set smaller reserves, or larger reserves in a recent report by Frontier Advisors even more interesting.

ILS funds have been setting reserves for the pandemic since as far back as March, with some proactive funds having looked through all of their contracts very early on to establish which should be side pocketed as early as possible.

As early as July, some ILS funds had been recording losses because of COVID-19, with further impacts seen in monthly reporting in each subsequent period.

But, the marking down of ILS positions for potential COVID loss impact has been going on for much longer.

Frontier Advisors, the Australian independent investment consultant, has analysed ILS funds it has data available for and concludes that on average, ILS managers have loss reserves set up amounting to 1.5% to 2% of capital for business interruption claims from the pandemic.

The investment consultant notes the uncertainty that exists over these reserves, given so much hinges on wordings of underlying reinsurance and retrocession contracts.

Which, of course, means that a reasonable amount of the loss reserves set for COVID-19 business interruption may also get released, as certainty increases and clarity over how wordings will be treated emerges.

For those ILS funds and managers with up to 2% of capital trapped due to business interruption, this is in reality no more than a small to mid-sized natural catastrophe event and sits well inside their expected losses for such a scenario.

But for some ILS managers, around 15% Frontier Advisors believes, the loss reserves for business interruption are at least double, at more than 4% of capital.

Frontier explained that the 15% or so of ILS managers that have loss reserves of over 4% tend to be the higher-risk focused strategies, with significant allocations to quota shares and also retrocessional reinsurance.

The quota shares are one of the clearest instruments in the ILS market that some losses from COVID will flow through, while retrocession is perhaps more laden with uncertainty given the underlying reinsurance portfolios a retro deal protects will not as yet have crystalised much in the way of losses themselves.

Frontier explains that any ILS arrangements covering contracts, reinsurance, retro, quota share or otherwise, that provide affirmative pandemic protection will need to have loss reserves set up against them.

While ILS arrangements subject to more ambiguous terms and policy wording, are the more challenging losses to estimate for, which Frontier says is leading insurers, reinsurance and ILS funds to all reserve more conservatively.

All of which suggests that a reasonable amount of the COVID-19 business interruption loss reserves set by the ILS fund market may well get released in the future, as ambiguity and uncertainty gets cleared up while actual losses get realised.

Adding to the uncertainty though, is the potential for further loss reserves to be required due to escalating second-waves of the pandemic around the world and particularly in the UK and Europe.

With England now set to enter a months lockdown later this week, while France and Germany have tightened their lockdown restrictions again, a winter of uncertainty is ahead for the reinsurance and ILS market.

Some had said before that second waves of the pandemic are likely to be construed as second events under some reinsurance programs, which if it turns out to be the case could impacts some market participants.