Evolution of ILS market and collateralized reinsurance set to continue

The insurance-linked securities (ILS) market, consisting of instruments such as insurance-linked funds, catastrophe bonds, sidecars and other fully-collateralized reinsurance structures, is set to continue to evolve in coming years, according to market participants.

Speaking at the ILS Bermuda Convergence 2014 event, held in Bermuda last week, industry experts and market participants suggested that the rate of evolution will continue, perhaps even accelerate and that innovative new business models and structures will help the market to continue on its growth trajectory.

The atmosphere at the event, which was attended by almost 300 market participants from across the world, was extremely positive with many suggesting that the ILS market is entering a new phase of consolidation and innovation, where innovative business models would assist in its continued growth.

There was certainly a feeling that the ILS market is maturing rapidly, with a number of new start-up companies looking to establish themselves with an ability to source pools of risk, provide structuring services and vehicles and then match that risk in a suitable form to investor capital.

With people seemingly now willing to take risks, break away from large established firms to set up their own ventures, with the knowledge that the investor communities appetite for access to insurance and reinsurance risks is as strong as ever, the future for the ILS market looks bright.

Tony Rettino, Founding Principal and Portfolio Manager at ILS investment specialist and fund manager Elementum Advisors, told the audience, during a panel he participated in, that he believes that “Sidecar like vehicles are going to evolve dramatically.”

The panel discussed how the reinsurance industry would be capitalised in the future and Rettino clearly felt that with further evolution of the structures involved likely, that there would be increased opportunities to put money to work in the asset class and further growth.

This aligns with some of the new business models that are emerging, which may see boutique startups looking to provide almost managed sidecar services to reinsurers and investors. These sidecar type vehicles may not look like the reinsurance sidecars we see today, rather being based on large portfolios of risk where the expertise is in sourcing, selection of risks, structuring and the ability to match them to the right capital.

Rettino said that he expects that the reinsurance market will continue to adjust to the changing sourcing and use of capital in the business, as well as the evolution of the underlying structures. He said to expect a “Pretty dramatic change in the next five or ten years.”

When asked what he felt about the ILS markets prospects for further growth and whether the growth rate could actually increase in coming years, Rettino said that he felt the growth rate could be higher, because the change being seen in the market is exponential. He added that, of course, this was with caveats as there could be events or issues which change the outlook, but while the status quo remains the same he expects to see exponential higher growth.

Marc Grandisson, CEO of reinsurer Arch Re, said that he expects to see more initiatives launching that are similar to his firms Watford Re play. Grandisson however warned that if the market moves to fast to a warehousing approach, to sourcing and distributing risks directly to capital market investors, there could be problems ahead and that the buy and hold reinsurance model still has a place in the market’s future.

Costas Miranthis, CEO of Bermuda reinsurer PartnerRe, said that he felt growth in ILS could be slower over the next couple of years, but that as we look further out, perhaps five to ten years, this could be a different story. Miranthis’ opinion seemed to suggest that a period of consolidation over the next couple of years could stimulate more rapid growth in the future.

Rettino said that the important thing to remember is that the ILS market is all about delivering the right capital and the right cost of capital to clients, while providing their risks to investors in the correct form.

The panel discussed the fact that reinsurance may increasingly move towards an origination model, with large players keeping some share of the business to show that they have ‘skin-in-the-game’. The market is moving beyond the traditional reinsurance buy and hold model, and reinsurers need to ensure they are ready for this by putting in place relationships to leverage different types of capital than just their balance-sheets.

The panel also discussed liquidity of risk and the fact that many investors still require this and the ILS market may need much more liquidity as it grows. The most efficient way to hold onto risk must be found by the traditional players, while they also need to identify which risks to offload to others whose cost-of-capital makes them more suitable.

Grandisson said that “standardisation of the product” is required if we are to see a truly liquid market. That means that certain risks will perhaps be more liquid than others in the future, as they are more easy to standardise. He added that he doesn’t see this happening any time soon.

Grandisson also said that for a liquid market to form you will need to see someone in the chain holding onto the residual or basis risk, in order to allow the rest of the risk to become liquid in a widespread traded market in reinsurance risks.

Rettino then discussed the need for increasing transparency in both the ILS and traditional reinsurance markets. The traditional balance-sheet has a higher cost-of-capital partly because it is so opaque, he said. Rettino said he “believes we can do better” and that the market can “lower the cost-of-capital with more transparency.”

Rettino also said that transparency will increase as the market matures and ILS players build ever stronger relationships with clients and cedents. “Fewer, deeper relationships lead to more transparency,” he said, something that we are beginning to see emerge as the market moves into a new stage of development.

It is a sign of the continued maturation of ILS that participants in the market are increasingly talking about issues such as transparency, liquidity, new business models and also the role that the traditional reinsurers will play in the future. As the reinsurance market continues to move beyond a purely buy-and-hold approach to underwriting risks, these conversations are set to continue and new approaches to doing reinsurance business and sharing that with new providers of capital will emerge.

Also read our other coverage of the ILS Bermuda Convergence 2014 event:

– World Bank set to bring more cat bonds, looks at health risk transfer.

– ILS is more than just an alternative to reinsurance: ILS Bermuda.

– Third-party capital could grow to 30% of Catlin business: Jardine.