ILS market COVID-19 losses “kicked down the road”, AM Best warns

The fact cedents allowed insurance-linked securities (ILS) capital to be rolled over into reinsurance renewals rather than trapping it for potential losses from the pandemic, for the ILS market “amounts to kicking the can down the road for COVID-19-related losses,” according to AM Best.

The rating agency warns that this could come back to bite some ILS funds, as cedents may decided to request holding onto the rolled-over collateral should COVID-19 pandemic related losses emerge further down the line.

In its latest report on the ILS market, AM Best highlights the ongoing issues related to potential pandemic losses and certain players exposure in the ILS fund market.

This is in collateralised reinsurance and retrocession strategies, with catastrophe bonds seen as clear of potential pandemic losses by now.

We discussed this issue at the end of last week, when we explained that the concerns over the potential trapping of ILS fund capital at the January 2021 renewal season proved overblown and that many cedents had preferred to secure their renewal, rather than subject ILS funds to trapping over IBNR estimates that as yet are unclaimed.

However, we noted in that article that Covid-19 related discussions continue, particularly for some retrocession strategies, while some disputes are also said to have begun over this issue.

AM Best believes the issue hasn’t gone away with the rolling over of collateral into fresh reinsurance and retrocession risk periods at renewals and that the pandemic could come back to bite some ILS players.

“An ongoing issue in the ILS market is the amount of trapped capital due to actual and potential losses from natural catastrophe events before 2020 and the COVID-19 pandemic, along with pre-emptive trapping (i.e. trapping capital without submitting specific reserves for damages as the pandemic remains an ongoing event). Some cedents accommodated ILS funds by rolling over their collateral into new contracts, rather than trapping it in anticipation of further COVID-19-related loss developments, although there is a risk that ceding companies could ask for the rolled-over collateral if losses emerge unfavorably,” AM Best explains.

“The rollover accommodation by the cedents amounts to kicking the can down the road for COVID-19-related losses,” the rating agency added.

AM Best warned that over the next few months court cases or arbitration could begin to settle how much, if any, capital can be trapped due to potential pandemic losses.

This will be largely based on COVID-19-related IBNR reserves, in particular for business interruption or event cancellation business, AM Best believes.

AM Best raises the issue of pre-emptive trapping of ILS capital and collateral, where it has been held based on estimates of IBNR but where the actual extent of a cedents indemnity loss is still completely unclear.

“Some ILS managers are concerned that some cedents do not have more visibility on actual COVID-19-related losses suffered by insureds,” AM Best noted.

Further explaining that, “These managers have concluded that the trapping may result from extreme conservatism by some cedents who do not want to release collateral that may be needed to cover claims in the future given the uncertainty surrounding the duration of the pandemic.”

While collateral was rolled forwards into renewals as cedents attempted to secure better terms at a challenging renewal where rates had been anticipated to harden, this may not prove to be in ILS fund managers favour every time.

“There is a risk that ceding companies may come back and ask for the rolled-over collateral if losses emerge unfavorably based on the prior year’s treaties,” AM Best warns.

This has resulted in a situation where “cedents and ILS managers are engaging in a subtle tug-of-war” over the amount of losses claimed under IBNR, versus the true claims picture.

ILS fund managers are asking cedents to more clearly define their COVID-19 related losses and explain their rationale for trapping collateral.

These are the ongoing discussions we referred to last week.

Given the importance of relationships in reinsurance, AM Best believes parties will be rational.

“AM Best believes that cedents and ILS managers are likely to settle disputes via arbitration, according to the terms of individual contracts,” the rating agency said.

But also warned that, “The tension between some cedents and ILS managers may persist until the pandemic has been mitigated or eradicated.”

Saying, “However this matter is resolved, it will ultimately affect how COVID-19 related losses are settled for both the ILS and traditional reinsurance markets.”

There is the potential for COVID-19 related trapping of ILS collateral to hang over the ILS market for some time to come.

But, at some stage, cedents will have to clearly state and back up their claim to holding collateral on any exposed reinsurance or retro positions, or give up such claims and move forwards.

Whether these potential COVID-19 claims will actually be realised or not remains to be seen and our sources in the ILS market in general believe that where collateral has been rolled over it would be hard for it to be held at the next annual renewals, unless the COVID-19 loss burden of some catastrophe reinsurance programs increases significantly from where they sit today.

Also read: Trapped collateral concerns overblown at 1/1, but COVID discussions continue.