Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Hurricane Ian ILS fund side pockets & trapped capital resolution continues


According to our sources, insurance-linked securities (ILS) fund managers are having continued success at closing down certain exposures to last year’s hurricane Ian, with a number of side pockets being finalised and trapped capital continuing to be freed.

ils-fund-side-pocketAs we’ve reported before, ILS fund managers have been able to steadily reduce the size of investment side pockets they had established related to hurricane Ian.

ILS fund side pockets are set up, by ILS fund managers, as a mechanism that allows for the segregation of assets that are potentially exposed to losses after a major catastrophe event occurs.

They act as a reserving mechanism, while trapping the collateral related to these assets to ensure it remains available to pay of any valid claims, or reinsurance recoveries.

As industry losses develop, it means the cedent’s reinsurance provisions remain available, held in a side pocket in case the specific reinsurance or retrocession contract attaches.

During the last year, in the case of major hurricane Ian and its September 2022 impact on Florida, the side-pockets that many ILS funds had established have proved to be more than sufficient for the eventual quantum of losses that cedents have utimately reported.

We reported back in November 2022 that side-pockets set up by ILS funds for hurricane Ian, focused on private deals and collateralized reinsurance or retro contracts, tended to range from as small as 3% to as much as 30% of a specific strategy.

Then, in January 2023 we reported that some of the side-pockets established by insurance-linked securities (ILS) funds in the wake of hurricane Ian are now being reduced in size, as estimates from the storm continue to trend lower than originally expected.

Most recently, in April, we reported that a number of ILS fund managers had been able to further reduce the size of hurricane Ian related investment side pockets.

Now, a few months on, we’ve learned of some ILS fund managers being able to close down side pockets related to hurricane Ian completely, as the loss estimates are finalised, any reinsurance recoveries are paid, and remaining collateral and capital flows back to their ILS funds.

In some cases we’ve been told that the eventual cedent recoveries made have proven to be significantly smaller than the remaining side pocket capital, even after those side pockets had been shrunk down already through releases of capital, as losses became clearer.

It’s another sign of the relatively significant overestimation of losses that the ILS market would take after hurricane Ian, similar to the occurrence in the catastrophe bond market, where losses ultimately look set to be just a relatively small percentage of the original mark-to-market impacts.

As we previously reported, some ILS fund strategies saw their remaining hurricane Ian side pockets reduced by anything between 30% to as much as 80%, and we’re now told some of those have finalised with zero losses, while others have finalised with relatively small losses and some additional returns of collateral and capital.

Uncertainty regarding how much damage Ian caused and therefore how big the claims would be for a cedent, and its reinsurance recovery, has now been clarified, allowing for accurate valuations of ILS fund side pockets in certain cases, which facilitates the payment of any reinsurance claims and the recovery of any remaining collateral, back to the ILS fund and its investors.

We’re told that ILS funds have seen more finalised loss reporting from cedents in the last few weeks and that as a result some side pockets are being finalised and any releases should flow back to ILS funds and investors over the next few weeks.

These are again very positive signs for how the ILS market’s reserving processes worked after hurricane Ian, also for the true exposure the market had to eventually become clear and some capital to flow back to ILS funds that had been operating with less available capital in recent months.

All of which should help the ILS fund market in preparing for its next major trading renewal, at the end of the year, with this experience also offering a good education point for existing and new investors.

The ILS fund market’s ultimate experience with hurricane Ian has shown a disciplined approach to claims reserving and management, that as a case study in how the ILS market reports might help in encouraging more capital to flow into the market in time.

However, we’re also told that there remains some uncertainty related to hurricane Ian for certain instruments and positons, particularly certain retrocession covers and also for industry loss warranties (ILW’s).

Given reported industry loss estimates sit close to the key $50 billion trigger point currently, it may be some time for clarity to emerge over any trapped ILW capital, which in retrocession it simply takes longer for reinsurers to understand the ultimates of their cedents, before they can deliver finalised loss assessments for their own positions.

We are told there is a chance of more releases of side pocketed capital related to retro contracts over the next few months, as the cedent reports help reinsurers gain a true picture of their exposure.

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