ILS fund & sidecar losses likely ahead of plan in 2016: Panelists

The level of catastrophe losses suffered by the ILS and reinsurance linked investment market are likely running ahead of plan in 2016, with events such as the Canadian wildfires impacting standalone ILW’s and likely to hit sidecar investors through exposure to quota share arrangements.

Speaking at the Guernsey arranged ILS Insight event in Zurich yesterday, Des Potter, Head of GC Securities EMEA, explained that the Canadian wildfires in particular was likely to hit some ILS funds and collateralised reinsurance sidecar investors.

“The first half of 2016 has been an interesting year for losses, with probably three reasonable size events so far, the largest being the wildfires in Canada and you can add to that some of the tornado hail events in the U.S. and the earthquake in Japan,” Potter explained.

“Each of those events it is estimated will generate over $3 billion of losses for the insurance industry and all three of those events will see a lot of that loss being borne by the reinsurance market.”

Potter went on to explain that some of the reinsurance sector loss has been retroceded into the ILS market, as ILS fund managers and sidecar vehicles provide global catastrophe support to major reinsurance firms.

“Either standalone ILW’s, and we’ve seen a couple of those in the Canadian wildfires,” Potter explained, “But also probably as part of the cessions in some of the worldwide property cat sidecars.”

At this stage the impact is thought to be minimal to any investors, with losses well spread out through the market and the vehicles involved meaning no single investor is likely to take an enlarged hit. But for managers and their investors these events are a good test of the ability to communicate losses to end-investors, as well as to pay claims in a timely manner.

Potter went on to explain that the impact to the ILS market would likely be relatively small.

“The losses so far, in the first-half of the year, will just be within the expectations of the budgeted loss ratios of these sidecars, although the level of losses in the first-half are probably running ahead of plan,” Potter continued.

The ILS market now faces a second-half of the year where any event such as a U.S. hurricane, even a mid-sized level of activity, could result in a serious impact on some of the returns to investors in some reinsurance sidecar vehicles, Potter explained.

So the ILS market sits poised with losses perhaps running ahead of plan in some collateralised reinsurance vehicles and funds, making second-half catastrophe loss activity a threat to profitability for the year. If we see further losses through 2016 the year could perhaps become the worst since 2011 for the ILS market.

However this would be with losses from a number of events, so more attrition than purely one or two large catastrophes, which reflects the broadening exposure of the ILS market as it expands into collateralised reinsurance, and also the broadening diversification of many ILS vehicles and strategies.

Neil Strong, Head of Non-Life at ILS manager Securis Investment Partners, explained the attritional nature and broader spread of losses being seen in the ILS market in 2016.

“There have also been European floods which have caused losses to European reinsurers, which have also fed through. You’ve had two rather large offshore energy losses, Pemex and Jubilee, some of that will end up I’m sure in the ILS market by way of proportional or again some of the sidecar quota shares,” Strong explained.

Strong stressed the need for active management by ILS fund managers, as a way to enable loss impacts to either be avoided or minimised. “I think we’re in a market environment where active management is key for our clients and looking at the investments we make for them,” Strong said.

Andreas von Reitzenstein, Underwriter with Credit Suisse Insurance Linked Strategies, agreed saying; “The losses so far this year have been minor and we will see some impact to the ILS community, via industry loss warranties and other collateralised reinsurance transactions. I think so far it’s not a massive issue.”

However, von Reitzenstein highlighted that the Canadian wildfire losses have surprised the market, with some primary insurance carriers seeing losses up to the second or third layers of their programs, which could result in changes to the Canadian reinsurance market pricing.

Simon Vuille, Portfolio Manager, Insurance Linked Strategies at Lombard Odier, said that the loss experience in 2016 underscores the fact that “it’s a very fragile environment.”

Vuille also noted the “pockets” of mark-to-market losses on catastrophe bond issues, referring to the Gator Re erosion of aggregate retention and highlighting the importance of active management once again, as managers have the option to move in and out of positions.

The ILS market and investors in ILS funds or collateralised reinsurance sidecars now sit poised to watch the second-half nervously for any further loss experience. Performance will not be the same across the market, as was evidenced in May when the Canadian wildfire losses resulted in a market average return of 0.12% for the month, but one single ILS fund was down -3.07%.

That shows the variation in ILS fund and investment strategies and underscores the fact that when there are events, the hit to ILS funds and investors will not be as evenly distributed as you might think.

Of course the one area that could result in a more event hit would be a major U.S. hurricane impact, but even then there will be winners and losers reflecting the wide range of strategies and differing levels of active management within the ILS market today.