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Original Risk: A Society for Change Agents

ILS capital getting closer to primary insurance risk: Butler, Twelve Capital


The innovation and evolution of the insurance-linked securities (ILS) space has seen its capacity get ever closer to primary insurance risk, supported by access to more detailed data and improved risk selection, according to John Butler of Twelve Capital.

Innovation in the ILS space is happening in two ways, says Butler, a Managing Partner and Head of Sourcing at specialist ILS and reinsurance investment manager Twelve Capital, the first being the variety of vehicles that investors are moving into the market and what that can provide to the sector.

While the second relates to the way “we’re accessing risk and how proximate we’re becoming now towards the primary insurance risk, whereas in the past we’ve been as a market more of a retrocession or reinsurance level writer,” said Butler in an interview with A.M. Best TV at the SIFMA IRLS conference.

Noting that he feels ILS’ evolution to get closer to the original risk is the fundamental change making its way through the market at this time.

Historically, ILS capacity has been utilised by insurers, reinsurers, and increasingly non-insurance entities, as part of the renewal process for reinsurance and also retrocessional needs.

However, the increased sophistication, willingness and understanding of ILS investors and market players to expand its reach and influence within the overall insurance and reinsurance landscape, a softening landscape, and enhanced data and analytic capabilities has driven a desire to get the capital as close to the risk as possible, potentially reducing costs and increasing efficiency.

Butler expands on this point; “Whereas now I think that whole chain from end investor through to retail purchaser insurance is starting to become ever more proximate. We’re finding vehicles and ways of converting risk, which are allowing the end investor to reach the primary consumer in ever closer ways.”

In recent months the softening reinsurance environment has persisted, continuing to pressure rates, limit growth and profit opportunities, fuelling re/insurance industry-wide competition and a wave of sector consolidation.

One of the ways ILS market participants can reduce their reliance on the more traditional reinsurance coverage available at renewals, and to mitigate the impacts of a challenging landscape, is to source and underwrite risk more directly, essentially jumping down the chain and eliminating the need for intermediary assistance.

One example of where this is happening in re/insurance and capital market investors are getting their capital much closer to the ultimate source of risk in the primary market, is with the MGA and fronting trend.

A number of companies are providing MGA services or fronting to ILS fund managers and investors, helping to channel risk from the primary market more directly to the ILS portfolios where efficient capital resides.

As ILS capacity becomes increasingly more proximate to the primary insurance risk, it breaks down the value chain Butler mentions, effectively taking steps out of the transactional life of a risk and removing steps of intermediation, thus further increasing efficiency of the risk transfer and capital used.

“One of the major improvements that gives us as a representative of the investor market is access to much better, much more granular data and the ability to select much more granular risk, a much more detailed view on the geographic risks and the line of business risks that we’re taking on behalf of our investors,” said Butler.

An interesting point, as in the past when ILS has mainly underwritten at the retrocession or reinsurance level, it’s much more difficult for firms like Twelve Capital to select certain tranches or types of risk for investors, whereas being closer to the risk enables the ability to better optimise portfolios.

This makes the risk selection process much easier explains Butler, as the firm can use technology and analytics in a greater and more comprehensive manner than previously.

Looking forward Butler feels the re/insurance and ILS space will see a continuation of this trend, as the overall market looks to access closer to the primary insurance side than before.

It’s worth noting that the more ILS capacity and its providers essentially jump the value chain and access the risk much closer on the primary side, it reduces their need for intermediaries such as the reinsurers and insurance and reinsurance brokers.

Supporting the fact that in order to remain relevant to the market and continue to add value to the risk transfer value chain, especially in the current softening landscape, it’s important companies continue to innovate and prove their value to the market.

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