Despite the increased maturity of the insurance-linked securities (ILS) and catastrophe bond market and the growing sophistication of its investor base, the disclosure of risk analysis in the offering document continues to add value, according to a panel of industry experts at SIFMA.
During the SIFMA IRLS 2016 conference held in New York recently, panelists discussed the importance and need for independent third-party risk analysis in the offering document of a catastrophe bond transaction, exploring whether there is still a role for such disclosure in the market today.
2016 marks the 20-year anniversary of George Town Re, the first catastrophe bond issuance of a market that has grown significantly in recent times, with a current outstanding market size of $26.151 billion, according to data from the Artemis Deal Directory.
During the last two decades the ILS and catastrophe bond sector has matured substantially, and its investor-base is now seen as sophisticated, skilled, experienced, and has increasingly shown a willingness to better understand the asset class and its exposures in order to adequately manage risk portfolios.
With this in mind, panelists discussed the value risk analysis provided sophisticated, and new ILS investors in the space, and whether it would be more efficient to simply omit this data from the offering document of the bond all together.
Pioneer Investment Management, Inc. Portfolio Manager, Charles Melchreit explained that his firm initially entered the ILS market roughly a decade ago, and while they now have in-house modelling capabilities related to their ILS investment exposures, this wasn’t always the case.
“I’m not sure we would have entered this market if it wasn’t for some robust, publicly available, expert opinions in the market,” explained Melchreit, raising a very important point.
True, the majority of capital markets investors that participate in the ILS and catastrophe bond sector, like Pioneer, are sophisticated and aware of the risks associated with an ILS investment, and therefore have established in-house teams that are able to model and asses the risks as a standalone investment but also as part of their overall risk portfolio.
Brett Houghton, Managing Principal, Fermat Capital Management, another investment manager in the ILS space, also underlined that many of the ILS investors in the marketplace today do have “very sophisticated in-house capabilities to model” ILS exposures, providing they are given adequate disclosure information relating to the book of business and the risks embedded in the bond.
Continuing to note that in most cases, and for an investment manager like Fermat that has experience in, and knowledge of the asset class, “it would not be a problem in most cases to not have a full-blown risk analysis included in the offering materials of these deals.”
However, as was raised by Melchreit, this likely isn’t the case for investors looking to allocate capital to the ILS asset class for the first time.
Despite knowing that an ILS or cat bond investment is linked to catastrophe exposures or longevity risk, for example, without the initial risk analysis explaining how the expected loss of the deal, the coupon and so on was achieved, new investors looking to enter the space might be wary of insufficient data surrounding the actual exposure.
Leading Melchreit to question whether choosing not to disclose risk analysis in the offering document would effectively limit the amount of new investors willing to enter the space, which ultimately “would be a negative,” said Melchreit.
Melchreit also stressed that greater disclosure and expert opinion is also a comfort and benefit to ILS portfolio managers, and that increased disclosure is also supportive of liquidity in the long-term, something that would be unfortunate to diminish.
And while Houghton disagreed that failure to provide third-party risk analysis would diminish market liquidity, he doesn’t think risk analysis should be forgotten completely with regards to an ILS investment-offering document.
A reason for this, explains Houghton, is for the remodelling services provided from both AIR Worldwide and RMS as a result of the initial risk analysis in the offering.
“So if you didn’t include a risk analysis at all in the initial offering documents for a transaction, I could envision a world where we have three views through a remodel service,” said Houghton.
Interestingly, the panel included Ben Brookes, Vice President, Capital Markets, at risk modelling firm RMS and Robert Newbold, Senior Vice President, Business Development and Client Services, at risk modeller AIR Worldwide, both of which are vastly experienced in the catastrophe bond market.
Brookes noted that RMS tends not to lean either way on the debate, as essentially, “what underlines all of this for us is the importance of understanding the risk, it really doesn’t matter to us whether that happens at the bond or at the investment part.”
Newbold underlined that as with everyone in the value chain of a catastrophe bond or ILS placement greater efficiency is needed and AIR’s keen to push for this when it can, but he doesn’t feel that efficiency or streamlining ILS should mean the overlook of risk analysis.
Newbold highlighted that George Town Re wouldn’t have been completed without some kind of risk modelling, and now the models and the information within them have become significantly more granular and complex.
Removing third-party risk analysis compromises several things within the offering says Newbold, including a common currency to which the industry can communicate, and also that it enables new investors to enter the space from a more prepared, and aware position.
The general view of SIFMA speakers, then, suggests that while it might not be vital for sophisticated ILS investors and investment managers to have disclosure information relating to risk analysis in the offering document, for new investors it is extremely important.
Furthermore, as highlighted by Melchreit and Newbold, without the inclusion of risk analysis new investors might not be so eager to enter the space, a trend that could mitigate the potential growth of the market moving forward.
Also, as underlined by George Town Re and the continued growth of the ILS and cat bond space, the market likely wouldn’t be where it is today without some kind of independent, third-party risk analysis and common currency on which to operate, at least at the initial offering point.