Swiss Re Insurance-Linked Fund Management

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ILS fund managers negotiate improved terms, buffer loss clauses at renewals


The ongoing renegotiation and fine tuning of terms and conditions related to insurance-linked securities (ILS) capital deployment continued at the key January reinsurance renewals, with ILS fund managers gaining some more ground.

HandshakeTerms and conditions had weakened across the reinsurance and ILS market during the prolonged period of softening of market pricing and rates.

Since the major hurricane season of 2017 and through the subsequent challenging period where ILS funds and collateralized reinsurance vehicles have been dealing with trapped capital and losses, as well as further catastrophe events, the market has worked hard to firm up terms and tighten conditions around its coverage and capacity, with some features of ILS structures seeing particular attention, including buffer loss clauses and tables.

The tightening of terms and conditions (T&C’s) has been ongoing alongside the firming of reinsurance and retrocession rates.

It’s the right time to respond in this way, as the negotiating position of capacity sources is perhaps at its strongest.

All through 2020, ILS fund managers were shifting themselves towards higher, or more remote, layers of reinsurance programs and towers, alongside pushing for higher prices.

At the same time tightening T&C’s enables the coverage to become more predictable and in addition a strengthening of the focus on named perils coverage, as well as the exclusion of anything deemed not covered (learned through the COVID pandemic), has also been seen.

At the reinsurance renewals, terms of coverage can be a significant driver of profitability for ILS fund managers resulting portfolios.

As we’ve explained before, the terms of coverage can be as important as rates and are on often overlooked factor in the return potential of an ILS fund portfolio.

Once again, at the January 2021 reinsurance renewals, ILS fund managers continued to push for more favourable terms when it comes to elements of the ILS product related to collateral trapping, release of collateral and the all-important buffer loss tables.

In particular, the collateralized retrocession underwriters, who came into this renewal in a strong position, as this market segment was not exactly awash with capacity and choice, have been honing their collateral related terms and conditions.

We’re told that some ground has been gained, particularly in the areas of contracts related to buffer loss tables and how those tables are constructed.

The details of these tables can be critical in the discussions over trapped collateral and with retro players in particular being involved in discussions with their cedents on this over recent weeks, largely related to potential COVID-19 exposure, there’s been a considerable focus here, we understand.

As ever, the goal is to make the returns more predictable from an ILS portfolio, removing uncertainty and the unexpected at the same time.

Which all comes to higher quality portfolios with a better, more consistent return potential, while eliminating the chances of unwarranted, or unexpected, ILS collateral trapping.

Poorly designed buffer loss tables can have a meaningful impact on an ILS fund or investors capital efficiency, ultimately raising the cost of that capital if collateral is too easily trapped.

Finding the right terms isn’t always easy, as you have two sides in the negotiation that come at the problem from entirely different positions, the cedent and the capital provider.

But, we’re told that realism has won out in many cases at the January 2021 renewal season, with enhanced terms in place and edits made to those loss tables that both make it more predictable and clear for the ILS investors, while retaining the important feature of collateral retention under the right circumstances for the cedent.

Negotiations over buffer loss tables were once again most evident in retrocession, as well as the renewals of quota share sidecars and private ILS transactions in quota share form, we understand.

Quota shares and sidecars have seen a significant amount of attention to their terms over collateral retention and release in the last few years and in some cases the terms are now seen as significantly fairer by ILS fund managers and investors.

Alongside these discussions, we also understand that there is a continued push for better quality and more timely data reporting, by cedents and their brokers. Another area where the ILS market’s continued attention to detail promises to result in higher quality portfolios of risk.

What’s interesting as well, is that we’re told that during negotiations, which are now all being conducted virtually, parties involved are seemingly finding ways to solve differences over terms much more productively than they had been in-person.

That’s an interesting aside to this, that perhaps negotiating virtually has helped the market maintain a more constructive approach to these discussions, resulting (perhaps) in better outcomes for all sides.

Of course, part of these negotiations is really the rolling back of years of terms creep, which can only be beneficial to all sides, in improving the risk transfer provided by reinsurance coverage and removing any ambiguity.

Also read:

Rate rises + tighter terms + dislocation + quality cedes = higher ILS return potential.

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