Rating agency Fitch Ratings said today that it approves of the UK governments plan to attract insurance-linked securities (ILS) business to its shores, as it seeks to grow the reinsurance sector, but says the scale of the impact it will have is uncertain.
The fact that Chancellor George Osborne has explicitly targeted ILS as an opportunity for UK reinsurance reinforces Fitch’s view that alternative capital is a permanent fixture of the insurance market.
The fact that the government would like to make the UK a hub for ILS is positive for the London reinsurance market as well, Fitch says, as it is likely to help the market maintain its leading position at a time when it is under pressure.
However, despite the positives, the scale of the impact is uncertain and depends on a number of factors, such as how any ILS regulations sit within frameworks such as Solvency II, which traditional reinsurance firms have to comply with, while the capital attracted to ILS may not.
It’s an interesting point, however Solvency II seems to treat fully collateralized reinsurance as meeting the capital requirements, the capital is always there after all. So it seems likely that fully collateralized ILS vehicles that were domiciled or launched out of the UK would likely pass the capital adequacy piece of the solvency question.
As alternative capital has flowed into reinsurance, in ILS and catastrophe bond type structures, they increasingly create challenges for traditional market players, Fitch notes.
These challenges will continue to exist no matter where ILS is domiciled, the rating agency explains, but adds that “A regulatory and tax regime that enabled them to be domiciled in the UK could potentially strengthen London’s position within the global reinsurance market, by allowing reinsurance providers to offer a more complete suite of products and services.”
The fact that the UK is targeting ILS and it gets mentioned in a budget shows the growing importance and influence of the ILS and alternative reinsurance capital trend, Fitch continues. It affirms the rating agencies view that this is permanent capital and a trend that is not going away.
“We believe a significant proportion of investors will remain even if yields in other sectors improved or a major catastrophe event leads to losses,” Fitch said.
Details remain non-existent on exactly what the UK government has planned, Fitch notes, and it says that there are “many uncertainties that could affect the attractiveness of London as a domicile for ILS and the impact on London Market insurers.”
The regulatory framework and how it would interact with Solvency II is one thing. Also questionable is whether a UK ILS domicile could ever be as attractive from a tax point of view as established domiciles such as Bermuda, Cayman, Guernsey and others.
The impact on reinsurers is also uncertain, as it will depend on their focus as to how this could impact them. Yes, the introduction of regulations to attract ILS business could bring more reinsurance business to UK and the London market, but would that benefit traditional players or simply all be snapped up by ILS and third-party investors?
Reinsurers competing directly with ILS and alternative capital may find it even harder to grow or maintain their market share, Fitch concluded, which given ILS’ efficient business model perhaps suggests that the UK government’s plan may not be the type of growth driver it clearly hopes for.