A significant portion of the capacity from insurance and reinsurance-linked investment funds is exclusively focused on catastrophe risks, but the willingness of ILS sponsors and investors, as well as lessons from the past mean that it doesn’t have to be this way, says Mike Millette.
Former Goldman Sachs partner and managing director, and now a founder and managing partner at Hudson Structured Capital Management, an investment firm focused on insurance, reinsurance and also transportation, Mike Millette predicts further growth of the insurance-linked securities (ILS) market underlined by continued sector evolution and the entry into a broader array of risks.
A total of 46 different insurance-linked funds and collateralized reinsurance entities, and eight hedge fund style reinsurers make up the bulk of the convergence markets, with an estimated combined capital and assets under management (AuM) of $59.9 billion, Millette said while speaking at the recent 2015 ILS Bermuda Convergence conference.
“Many, many of the entities are entirely devoted to cat, and even the ones that aren’t tend to be primarily in nat cat,” explains Millette, noting that between 90% – 91% of risks in the convergence markets is natural catastrophe focused.
This highlights just how concentrated the ILS market is on certain, easy to model and easier to access risks, and further bringing to light just how much of the glut of alternative reinsurance capital has focused on already competitive, pressured business lines.
However, according to Millette, there are a few ILS funds that have as much as 50% of their investment portfolio dedicated to other risks, and this has been increasing over time and will continue to do so in the future.
An area of particular interest to Millette, and most notable with the eight hedge fund reinsurance entities that have a combined total of $7.99 billion in terms of shareholders equity, is the growing presence of non-elemental and attritional risks. The former referring to property risks outside of natural catastrophe risks, like casualty, and the latter concerning risks like auto and frequency risks.
“So these hedge fund reinsurers look very different (compared to ILS funds/managers), their mission is different. Their mission has to do with providing investors with some insurance risk but overwhelmingly with providing investors with investment risk,” explains Millette.
Interestingly, Millette claims that at some point during the last 20 years, “virtually every risk in the insurance and reinsurance universe has been packaged in a tradable form at some point,” a notion that really supports the foundation of his claim that risk concentration in ILS can be reduced.
The reasons ILS has almost exclusively focused on nat cat are plentiful, and include advanced modelling, better understanding of the overall exposure, and the short nature of the tail risk and short duration of the term, “there are all kinds of reasons why nat cat yields to securitisation structuring,” says Millette.
But as Millette says, virtually all other risks in the sector have been securitised at some point, meaning they could be again in the future, which really is the main argument for why he feels ILS can, and will have a greater impact and influence on risks outside of nat cat.
“We now have many of the funds that have marine, aviation, per-risk, crop in some fashion in their fund. They are doing it through collateralized reinsurance, we always talk about the tail, but you can develop a commutation feature into these, and in fact people are already doing it, this isn’t even theoretical,” continued Millette.
Further proof that this is already being done in some capacity is the fact that of the near $60 billion combined capital base of the 46 entities, only 90% – 91% is focused on nat cat, signalling that 9% to 10%, or roughly $6 billion, is sitting in funds that is not natural cat risk.
“The first reason it doesn’t have to be that way is keep in mind it has been done, virtually every risk has been securitised, the fact that 90% of what’s in our funds is cat risk doesn’t make that determinate,” explains Millette.
The other reason Millette feels ILS will move into other risks is down to the investor base, and a growing one at that, which are very willing and keen on the diversification, and low correlation aspects of the ILS market, and according to Millette are also keen to explore other risks.
Millette expands on this point; “So not only have we seen these types of risk securitised, and not only do we have some investor demand to see them securitised, or structured into alternative trading vehicles, but I think that we will simply see that happen because the companies themselves will be seeking more effective trading markets in order to manage their balance sheets.”
Investor appetite and demand, and the fact that ‘it’s been done before’ are valid and sound reasons for the belief that ILS will move into other risks in the future, but it’s important to remember that without adequate data, modelling, analysis, and expert underwriting capabilities in emerging ILS risks and regions, entry into new exposures will be extremely difficult.
But should the increased sophistication, understanding and acceptance of ILS structures, investors, and capital continue the trend of the last few years, it’s easy to see why Millette feels so confident that it can, and will happen in the future.