Swiss Re Insurance-Linked Fund Management

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ILS investors willing to discuss collateral release for longer-tail risks


With the ILS market poised for further expansion, potentially into longer tail business lines, end investors of fully collateralized products are open to discussions regarding the duration and inherent complexities of collateral release, according to industry experts.

Collateralised reinsurance is widely regarded as the fastest growing sub-sector of the insurance-linked securities (ILS) space, with ILS managers and funds being seen to participate in traditional reinsurance placements on a fully collateralised basis more and more.

In reality, collateralised reinsurance placements rarely face a loss, but as this particular element of the ILS space continues to broaden its scope it’s possible that losses might creep also, bringing to light the potential for collateral lock-up and discussions surrounding the duration of collateral release.

During the Artemis SIFMA IRLS Executive Roundtable 2016 industry leaders debated collateral release in fully collateralised ILS contracts. Roundtable participants discussed the potential for ILS capacity and features to play an increasing role in longer-tail business lines, such as casualty, but were quick to stress the importance of understanding potential collateral release issues that can arise.

Discussing ILS and collateralised reinsurance playing a greater role in longer-tail lines like casualty John Butler, Managing Partner, Head of Sourcing at Twelve Capital, noted a potential need to find new and alternative vehicles to take on that risk.

“Investors, as they become more educated, are more comfortable to discuss those kinds of issues and gain an understanding in how this business can be priced and monitored. It can be done, it’s there; more business will creep this way,” said Butler.

As evidenced by the continued growth and impressive sophistication of the ILS markets in more recent times, ILS investors are now more mature and demand a greater understanding of the risks and workings of their investments. A trend that will only support the entry of ILS into new and longer-tail lines as the potential pros and cons are well explained and properly understood.

“The other thing is the duration of the risk period that investors are willing to take. I think that the end capital markets funder is open to the story around collateral release if it’s a well-thought-out story; it’s not just, “Hold my capital for ten years,” and, “I have no way of getting it out,” even if you don’t have the loss levels that you want,” said Cory Anger, Global Head of ILS Structuring at GC Securities.

Anger explains that when the market was in its infancy development periods of one or two years were the norm, and over the last several years this has moved to three years, so for a number of years collateral release has been getting longer.

Typically, a collateralised reinsurance placement last for six-months or a year, with risk periods in catastrophe bonds ranging from six months to as much as five years, and even longer in certain instances.

With losses rare for investors in the collateralised markets, investor collateral is typically returned within a reasonable time after the contract has expired. However, when losses do occur it can take some time for the costs to be calculated, meaning that investor capital is locked-in, which ultimately means investors can’t access capital that they may wish to deploy elsewhere.

But should collateralised ILS funds and investors begin to participate in longer-tail business, be this casualty and alike, or simply longer-term natural peril deals, then losses become more likely and even a near certainty in some cases, highlighting the need for discussions around the duration of collateral release.

Anger states that investors in the space are open to ideas and proposals that enable them to invest in longer-tail insurance risks, so long as the notion is a well-though-out one. For example, explains Anger, this could include “mandatory capital releases above some buffer after a specified time period.”

Jean-Louis Monnier, co-Head of ILS, Swiss Re Capital Markets, stressed that collateralised markets participating in long-tail risks can be tricky, and that innovation is required to find the best solutions that enable ILS investors to step in.

“What’s then the best structure, structure that works, for the capital market to just step in? At the moment, I think this is an area where the rated balance sheets have an advantage. Among the reinsurers, actually the better-rated ones are the ones that are doing the largest deals,” said Monnier.

Anger also called for innovation and a need for cooperation between the investors, cedents and intermediaries.

“It is partly that on the intermediary side we need to be pushing the dialogue with both constituents. It can’t be just a one-way; it’s a balancing act, but I do think we need to take a step back.

“What is it that the cedent needs and what do they need out of that product to drive the growth? Then couple that information with what are the real sensitivities on the capital market side? And not be beholden to a particular design of structure; otherwise we would have never advanced,” said Anger.

It appears ILS investors are willing to become more influential in longer-tail lines, likely helped by the fact that high competition in the property catastrophe space has diminished returns here.

But in order for collateralised markets to really play a part in longer-tail exposures it’s important that complexities and uncertainties, like collateral release are properly understood and accounted for. Which will surely require cooperation from all parties involved and innovation.

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