ILS innovation presents need for higher level of board expertise: Taylor, Ocorian

Due to a shift away from commoditisation in the insurance-linked securities (ILS) sector, diversity and innovation are becoming essential, which has increased the need for a higher level of board expertise, according to Ocorian Client Director Sherman Taylor in a recent interview with Artemis.

In Bermuda, Special Purpose Insurers (SPI) are used as vehicles for ILS deals, such as catastrophe bonds, and must stick to a strict regulatory environment that includes a code of conduct, with a requirement for a board to be composed of directors with enough expertise on the subject matter.

Taylor noted: “There is a clear shift away from commoditisation in the ILS sector, and diversity and innovation are increasingly evident. Naturally, this increases the level of board expertise required.”

He then went on to explain that within the past five years there’s been a broadening of the general structure of ILS deals, with the incorporation of new technology and adopting ESG into ILS platforms.

And, at the same time, the ILS asset class also covers less conventional risks such as credit default risks and operational risks, while the geographical areas of cover have also expanded, with ILS deals now covering regions of Latin America, Asia and Africa.

“Taken together, these trends mean that boards must have similarly broad commercial experience and a thorough understanding of the ILS market.

Taylor also believes that board expertise is particularly important when commercial challenges arise, as demonstrated by the global COVID-19 pandemic.

“Whilst direct losses from COVID-19-related pandemic risks were mostly limited to the World Bank’s pandemic cat bond, anxiety remained high about losses attaching to ILS; some ILS funds even mad provisions for potential losses,” he continued.

“This highlights the need for boards to have the necessary fiduciary expertise required in order to effectively guide SPIs through events sitting outside the normal course of business.”

He also noted that sound corporate governance at the SPI level plays a key role in the future of the ILS sector.

“There are significant growth opportunities for the asset class as investors seek to diversify their portfolios to reduce exposure to equity market shocks (such as the one precipitated by Covid-19 in 2020).

“However, the ILS sector must retain the confidence of the capital markets to continue to realise these opportunities, and good governance is fundamental to this. Success can be seen in the form of new ILS funds being established on the back of excellent performances from exiting ILS funds,” he continued.

Sherman continued to explain that specialist knowledge at board level should always be required when conducting both the larger 144A ILS or cat bond deals, as well as the smaller collateralised reinsurance deals.

Although he believes it’s the latter which tends to be more innovative and customised, and are more likely to have unique structural features because they are directly negotiated between participants.

Most ILS deals are listed on the Bermuda Stock Exchange and there are continuing obligations that issuers must comply with, while the board must be aware of the additional responsibilities placed on the SPI by virtue of its securities being publicly listed.

He added: “The board must also have a strong understanding of the legal and regulatory environment its structure is situated in, ensuring the vehicle keeps up with regulations, operates transparently, and avails itself of the most beneficial rules available.”

For example, in October 2019 Bermuda revamped its regulations for SPIs, providing a 15-day grace period for collateral to be in place in ILS deals.

He concluded by saying: “Good corporate governance has played an important role in the success of the ILS sector, and it is no surprise that ILS is becoming increasingly recognised as a traditional asset class.”