COVID-19 business interruption hit to ILS seen as minimal

After canvassing a number of insurance-linked securities (ILS) investment fund managers and end-investors for their views on possible loss impacts due to the COVID-19 pandemic, the majority strongly believe that impacts from the business interruption issue will only be minimal to their ILS strategies and ILS portfolios.

This goes for ILS investors allocating capital to reinsurance and retrocession contracts which carry an element of exposure to the property business interruption issue, which is still largely expected to manifest itself in the proportional world of quota share investments and reinsurance sidecars, our sources said.

All of our sources agreed that there is the potential for this business interruption related issue to be a bigger trapped capital threat than an actual threat of losses, with uncertainty the driver.

But, as legal cases continue to go in favour of insurers for now, with contract law looking set to be the ultimate winner, this uncertainty may lessen over time and by the end of this year the case for trapping collateral may be less weighted to the cedant, some expect.

But that threat will persist and some collateral will be trapped, as cedants are unlikely to want to release reinsurance and retrocession collateral as long as COVID-19 business interruption uncertainty remains.

The overall threat of this translating into losses is seen as less severe.

ILS fund managers in the main do expect to experience some losses from the coronavirus related BI issue, with some suggesting these losses will likely range from minimal to modest in the proportional and quota share end of the market, depending on the cedants ultimate exposure.

However, when looking at the potential for ILS market losses from the pandemic it is important to consider where losses are falling for the cedant universe and the fact that the majority are being reported in lines of business away from property.

So, take a major global reinsurance company with a few billion dollars of ultimate COVID-19 losses expected.

Out of this the vast majority will likely fall to lines of business such as event cancellation, travel, contingency and financial lines, as well as certain longer-tailed casualty exposures which have yet to manifest.

But the commercial property line of business exposure is where the majority of business interruption claims will be seen and there are two factors suggesting this won’t be as big an issue as some have suggested.

First, the average cedant, such as this hypothetical major global reinsurer, will see claims in its property book that are likely less than a quarter of its overall COVID-19 ultimate. The majority are expected from other lines, while the property books make up a smaller share (in the great majority of cases).

Which means that even in the quota share and reinsurance sidecar world the loss impacts may be more limited than thought.

Secondly, the ILS market has far more exposure to residential property, than it does to commercial property.

Which means many ILS fund managers will be insulated from COVID business interruption, as they don’t really carry much (if any in some cases) exposure to commercial property lines.

Some ILS funds have already marked for the full potential exposure they expect, while others are doing so at this time, especially in the quota share world where some sidecar marks are now getting adjusted for the effects of second-quarter result reports that have recently come out.

Some uncertainty related to hours clauses and how they related to COVID claims remains, but this is also not expected to be too much of a factor in amplifying losses for the ILS market.

Of course, as with any unprecedented global insurance and reinsurance market loss event, like a pandemic, uncertainty remains and could intensify if coverage legal cases began to go the way of plaintiffs in the United States.

In addition, second waves of COVID have the potential to ramp up uncertainty and drive further losses down the market funnel towards the ILS and collateralised end of reinsurance and retro.

So, time will tell. But our sources are confident at this stage that the overall impact to the ILS market will be relatively limited, in the grand scheme of industry events and far smaller than the impacts that a major hurricane, or other natural catastrophe, would have on ILS funds and their investors.