Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Convergence of capital markets and reinsurance only just begun


Around twenty years into the convergence of reinsurance and capital markets there is a feeling that the trend is still in its infancy, with the direct connection of capital from institutional and increasingly more private investors to risk having a long future ahead.

The trend, of connecting investor capital to risk, really began much longer ago, of course, with investors capitalising Lloyd’s of London underwriting vehicles, however it is the fully-collateralised nature of the insurance-linked securities (ILS) market that has seen the wave of interest increase dramatically over recent years.

Around 20 years ago the first catastrophe bonds and similar transactions came to market, as the capital markets found it could securitise risk into a liquid, transferable form, which was assumed to be the most appropriate for an institutional investor.

The catastrophe bond remains a key piece of the ILS market, but of course the growth of collateralised reinsurance and other ways of securitising risk linked assets have grown in popularity and now make up the bulk of the ILS asset class.

But twenty years into this trend you’d think the ILS asset class would have come of age? Not according to speakers at a recent Standard & Poor’s conference, who stressed that the convergence of reinsurance and capital markets has only just begun.

Of course any of our regular readers would be aware that the ILS market just keeps on getting more interesting and intriguing, as ILS fund managers expand into new perils, find mechanisms to more directly access primary sources of risk, disintermediate the market value-chain and begin to put technology to work to connect risk and capital.

All of which suggests the convergence trend has a long way to run and that, within the global insurance and reinsurance market, ILS and the capital markets are set to play an increasingly important and influential role in years to come.

Speakers at the S&P conference explained that the “low hanging fruit” in reinsurance had now been picked by the capital markets, reflecting the entry into the more easily modelled, peak catastrophe risk exposures where the ILS market continues to largely sit today, according to a report on the event by analysts Bernstein.

Traditional reinsurance players continue to maintain an advantage in other lines of business, thanks to rated balance-sheets and leveraged capital, which has made penetrating deeper into the sector a more technical (structural) task.

But ILS fund managers are finding ways to access new types of risk from the broader reinsurance and insurance markets, either through relationships with rated players, or through their own rated vehicles. Leverage has also been applied to some ILS capital, to a degree, through the structures used to host and deploy capacity.

These gradual developments, as the major ILS fund managers explore structures that allow them to shift their capacity closer to the ultimate source of risk, should ensure continued growth for the sector and continuation of the convergence trend.

What form the ILS market takes in years to come is not as easy to forecast, but the idea of pools of capital (funds or other vehicles) more directly connecting to, underwriting and collateralising re/insurance risk is one that is here to stay.

The speakers at the S&P event discussed the “huge” sums of capital on the sidelines of the ILS market, with the insurance-linked asset class now more widely appreciated among institutional and capital market investors.

As a result the continued convergence and expansion of ILS into longer-tailed, more asset intensive lines of business was forecast at the event, as investors get increasingly comfortable with the data available and the types of structures required to back other classes of risk more broadly, such as life, casualty, specialty and others.

The analysts at Bernstein note that this is a point of “optimism” for the ILS market and alternative capital providers, but of “concern” for the traditional reinsurance market.

Investors like and appreciate the scientific approach to modelling of insurance risk, the availability of data, the underwriting process and the technical structuring involved in the ILS market. However, the market is limited to a degree, both due to reinsurance demand and the fact a lot of the world’s catastrophe or weather risk is uninsured, the speakers at S&P’s event explained.

However, once again the ILS market is set to innovate, both alone and with the help of others, in order to expand into areas where risks are not currently insured, or even where there is no insurable interest, but contingent capital protection against risk is required.

The speakers, who included Judy Klugman, Global Co-Head of ILS, Swiss Re Capital Markets, Brett Houghton, Managing Principal, Fermat Capital Management LLC and Mike Millette, Managing Partner, Hudson Structured Capital Management, all noted that as ILS grows claims will get paid, due to the contract certainty embedded into the structures.

Of course, the continuation of the convergence trend is a pretty well established expectation in the reinsurance market and even the large traditional players are, in the main, ready to admit that leveraging ILS structures and capital markets capacity is increasingly set to be part of their future too.

The reinsurance market looks destined to be one where the shorter the connection between risk and capital, the more value can be extracted. This is akin to so many industries, where value-chains have shortened and technology has aided efficiency, capital has forced this on reinsurance and now technology in the form of the insurtech trend will take that to the next level.

Efficiency capital, ILS or capital market structures, technology, minimal intermediation, fluid syndication of risk, broad diversification of capacity providers and rapidly responding contract payouts; a future of the reinsurance and ILS market which will ultimately benefit the insurance consumer.

As convergence continues and deepens (as we wrote it would almost two years ago) there will be pain for the traditional market, some intermediaries as well as for smaller ILS players who cannot move as quickly. But for those who embrace the capital markets early and are ready to innovate and adapt, this convergence wave will be available to ride for a good while longer.

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