ILS Capital in landmark $57m trapped capital securitisation

ILS Capital Management Ltd., a Bermuda headquartered ILS fund and reinsurance investment manager, has successfully completed a landmark securitisation that reduces the level of trapped capital affecting its ILS funds and returns capital to investors, seeing it as the first ever securitisation of trapped ILS capital.

In doing so, ILS Capital Management has successfully returned value from its trapped ILS capital and collateral back to its investors, while also maintaining upside potential in the trapped or distressed reinsurance assets.

Trapped ILS capital, or trapped ILS collateral as it’s also known, is a problem that has beset the insurance-linked securities (ILS) sector over recent years, as consecutive heavy catastrophe loss seasons meant that cedents held back on releasing capital from ILS trust accounts, leaving managers with the heavy burden of a growing amount of capital that could not be deployed while it was held back for the potential of losses developing under its related contracts.

Collateral can be temporarily held by counterparties in reinsurance transactions, allowing for potential losses to develop and meaning the capital is not available for reinvestment until the claims are settled or discounted.

The solution has always been thought to be a secondary market in trapped ILS collateral, something that has been attempted in one-off transactions, and numerous investors such as hedge funds, as well as legacy or run-off reinsurance players, have looked at opportunities to buy-out trapped or distressed ILS positions, but as yet nobody has done anything meaningful in this space.

ILS Capital Management has now achieved this, securitising a portion if its trapped capital, which has then been syndicated and sold to investors.

The fund manager has completed a $57 million offering of 5.50% asset-backed notes, which represent “a securitization of the residual value of trust accounts supporting reinsurance contracts, what is known in ILS circles as trapped capital.

ILS Capital completed the offering of trapped ILS capital securities using a newly formed subsidiary named Parliament Street Finance.

BNP Paribas’ Debt Private Placements and Asset-Backed Securities syndicate desks marketed the placement to investors and the $57 million of 5.5% trapped ILS capital notes were placed with investors from global and regional asset managers and insurance companies.

The deal represented trapped capital, or collateral, related to 51 contracts that are potentially impacted by 18 catastrophe events from across the last three years.

Impressively, the transactions represents 70% of the total trapped capital across ILS Capital funds as of January 1st 2020, so with this arrangement ILS Capital has made significant strides in freeing itself from that burden of legacy.

The asset manager notes that, “More broadly, this transaction paves the way for similar reinsurance securitizations benefitting investors, with the potential to unlock a substantial portion of the industry’s $15 billion in trapped capital.”

Tom Libassi, Co-Founder and Managing Partner of ILS Capital, explained, “We are delighted to have completed the very first transaction securitizing so-called trapped capital, solving an issue that has vexed our industry since it came to light following the losses related to the natural disasters of 2017 and 2018. By unlocking capital that would otherwise be kept from being redeployed, this transaction gets money back into the hands of our investors more quickly, making it available for new investments while still providing our investors with potential upside.”

It seems this is a transaction that could be replicated and by taking the approach of securitizing the residual value of the ILS trust accounts, it provides a way to give ILS fund managers and investors some comfort that the potential up and downside have been considered, before the trapped capital has been sold on.

This transaction positions ILS Capital Management with less legacy at a time when the forward-looking outlook for the ILS market is good and investors are looking for ways to deploy capital into the sector, but the levels of trapped capital affecting the market has been noted and become a concern for some.

By clearing the decks, so to speak, of this legacy, ILS Capital has positioned itself well for the future at a key point in the ILS and reinsurance market cycle.

BNP Paribas served as Sole Structuring Advisor and Sole Placement Agent for this securitisation of ILS trapped capital, while Goodwin Procter LLP and ASW Law Limited served as legal advisors. Mayer Brown also provided legal counsel to the investors backing the transaction.