Cat bond market in need of more sustainable, original risk: Johansmeyer, PCS

Tom Johansmeyer, Assistant Vice President, PCS Strategy & Development at ISO, launched the Verisk Insurance Solutions reinsurance initiative, and works closely with global reinsurance and capital markets stakeholders worldwide to identify critical needs and collaborate on solutions to address them.

Artemis spoke with Johansmeyer about the evolution of the catastrophe bond market, a sub-sector of the insurance-linked securities (ILS) space that he describes as innovative, but that is in need of more original risk.

New and existing business lines were also discussed, such as cyber, terror, and energy and marine, with a thought to where the ILS space could play a more meaningful role, ultimately expanding its presence outside of the property catastrophe space.

What’s Missing from the catastrophe bond market?

In April, there was plenty of optimism. The catastrophe bond market was off to a fantastic start. Although there were no new sponsors, issuance activity climbed a third, reaching $1.6 billion. And that significant growth rate came on top of a record-setting first quarter in 2015. What happened next? The market slowed down. Absent a massive Everglades Re transaction in the second quarter, let alone any other public sector participation, year-on-year issuance declined significantly. What’s been missing? Simply put, the catastrophe bond market needs more original risk. And it has to be sustainable.

How is the Cat Bond Market evolving to enable it to take on more original risk?

Interestingly, there’s been no shortage of innovation around original risk over the past few years. We’ve seen several corporate catastrophe bonds come to market. The transportation sector has featured prominently, with transactions from both the Metropolitan Transit Authority (MetroCat Re) and Amtrak (PennUnion Re). The Turkish Catastrophe Insurance Pool (TCIP) has come to the catastrophe bond market twice, and Panda Re brought the first opportunity for investors to consume catastrophe risk from China in securitised form. Operational Re made new risks available to the market, and Bellemeade Re brought mortgage insurance risk. Recently, plenty of publicly managed entities sponsored catastrophe bonds, particularly in 2015.

However, the market-wide results of those efforts have been limited. The public sector may return to the market, but the only transaction from it completed in 2016 was the latest Ursa Re. The TCIP was the only repeat sponsor in the geographical diversification new entrant class, and corporate participation has been thin – despite interest from both cedants and markets.

Innovation is always important, and the market should celebrate every accomplishment of this sort. That said, at least a handful of these new ideas need to stick and achieve some scale to drive sustainable market growth and absorb the (substantial) additional capital that wants access to insurance and reinsurance risk. The only reliable way to do this is to focus on the most acute needs the industry faces.

Or – to put it bluntly – listen to your clients.

What are the main areas of focus and innovation for new business avenues?

Through the run-up to the 1 January 2017 reinsurance renewal, which feels like it began 2 January 2016, we’ve focused on what really are the most important challenges the industry as a whole faces and what would help address them. When you look at the broad spectrum, you see a lot of surface issues that point to something fundamental. Yes, there’s the ongoing pressure on rates from abundant capital (both ‘alternative’ and otherwise). There’s continued reliance on U.S. risk, particularly Florida wind. And there’s the shift from catastrophe bonds to collateralised reinsurance. Ho hum. The list goes on, and just about anyone in our industry can recite it chapter and verse. What these symptoms point to, ultimately, is the need for more original risk. Investors need alternatives. And cedants have risks they’d like to transfer in new ways – using approaches that currently aren’t available to them.

So far, this is all pretty squishy, but to get specific, it really comes down to three specialty classes of business: energy and marine, cyber, and terror.

What new approaches to risk transfer could help to open up (energy and marine) these new business classes?

Everyone who’s met with me has heard me ask, what do you think we should be expanding into? When I first started asking this – in my early days with PCS® – the most frequent answer I received was energy and marine. And the momentum hasn’t subsided. The demand to lay off energy and marine risk is palpable. The ILS community wants to assume it, and the insurance and reinsurance industry wants to transfer it. New approaches to risk transfer here could lead not only to savvier risk and capital management, but to new opportunities for capital deployment and diversification. Particularly if energy and marine risk could be securitised (with a credible index, of course), the amount that ILS funds could assume may increase, creating new opportunities for insurers and reinsurers to deploy capital to additional risks.

The most important step to opening up energy and marine risks to the global ILS community is the establishment of a global index, which is why this effort is the PCS team’s top new market priority right now. Existing risk-transfer alternatives – even with the abundance of traditional capacity purported to be available – simply don’t address the full market need, as expressed by cedants.

Energy and marine may not meaningfully absorb the capital interested in gaining access to insurance and reinsurance risks, but it would be an important first step. And it would likely prove the concept for other specialty lines to follow. If each specialty line could become a bigger smaller business for the ILS space, the overall impact could begin to help alleviate the capital overhang that the industry has contended with for years.

What do you see as the obstacles to expansion into cyber and terror risk?

Everyone wants it, but nobody knows what it is, it seems. Cyber has taken on many forms. Physical damage. Liability. Inclusion in property catastrophe programs. Cyber terror. The concept is nebulous, but the risk is massive – with plenty of potential for more of it to be written at every link in the global risk and supply chain in the coming years. Interestingly, when people answer my question about what PCS should do next, energy and marine is spoken with emphasis. Sometimes, cyber is almost posed as a question: Cyber? Could you do cyber?

The appetite exists – both to lay off cyber and to assume it. Questions remain, though. What’s the best way to transfer cyber risk? Parametric, industry loss, or indemnity? How do you define a cyber event? Should state-sponsored be included? How do you know if an event was state-sponsored? For that matter, should cyber terror be included?

So, the universal thought on cyber seems to be, Yeah, it’s a tough one. And, of course, it is. That makes it even more important for the industry to figure it out. While the likes of energy and marine and terror can become bigger smaller markets, cyber could become quite large. It has the potential to transform the ILS market, particularly if a solution for cyber liability could be applied to other liability and long-tail risks.

In what ways are the original risk opportunities for terror emerging?

Terror is interesting within this group of specialty classes. Historically, it’s been a small market. Yet it has the potential to become a bigger (even nontrivial) small market. It won’t solve the excess capacity challenge the market faces (no individual risk will, most likely). But smaller risks such as this can help – together providing significant aggregate opportunities to deploy capital, diversify, and relieve the industry’s reliance on U.S. catastrophe risk.

Of course, the reinsurance and retrocessional sectors would benefit from more original terror risk entering the global risk and capital supply chain at the primary market level. But it seems that such grassroots effort isn’t necessary to put the market in motion. Already, the need to move risk exists. As global property catastrophe programs have begun to include terror risk (in some cases), retrocessional demand for terror seems likely to increase in 2017. Once accumulations get too high, the benefits of risk transfer will become salient, and action should follow.

Additionally, there is the original risk opportunity emerging in the primary market. To date, the reinsurance community has focused on property damage from terror, with high attachment points for massive events – which have been quite rare over the past 30 years. Meanwhile, the terror threat on the ground has shifted, with active assailant events causing fatalities and casualties (but not physical damage) becoming the norm. Risk managers should be talking to their boards of directors (and many are), especially if their businesses represent soft targets: schools, shopping centres, and hotels come to mind immediately. As primary market solutions gain momentum, these risks will find their way into the reinsurance and retrocessional markets worldwide, creating meaningful opportunities to write new business and refine risk and capital management.

How will the entry of these specialty classes contribute to sustainable growth in ILS?

The entry of specialty classes into the ILS space provides two significant benefits. The first is scale. Rather than see risk transfer in this sector as a one-time experiment, a proof of concept could quickly lead to subsequent transactions, creating a pipeline for everyone involved in ILS activity. That’s the sort of organic growth the sector could use. Additionally, transactions involving energy and marine, cyber, and terror could provide a foundation for bringing other specialty lines into the ILS space. And from there, the platform could be used to include commercial liability risks, as well.

There are several ways to attain growth based on some early successes in specialty market ILS risk transfer. The key is to provide a credible index, complete a transaction, and do it in a way that’s repeatable (which is where an index helps). If the first can serve as a model, more activity will likely follow, providing a new source of growth in what has been a challenging market.

Read previous Artemis interviews here.

Join Artemis in New York on February 3rd 2017 for ILS NYC