The ongoing Covid-19 pandemic is expected to have a limited impact on the life insurance-linked securities (ILS) sector, and despite the outlook for life insurance markets being downgraded, the future looks positive for life ILS.
This is according to Luca Tres, Partner at Securis Investment Partners, who in a recent interview with Artemis, discussed the outlook for the life ILS space in light of the current coronavirus outbreak.
“Although mortality risk is one of the main risks of the whole life insurance value chain (insurance companies, reinsurers and ILS funds), the impact of the current coronavirus outbreak is not expected to be material for the industry.
“The impact for the life ILS sector should be even more manageable and it should be confined to the transactions (mostly public) that are exposed specifically to extreme mortality and pandemic, a lateral market for the sector,” said Tres.
Tres explained that any impact should be limited as the firm has near enough exited the public market over the past few years. According to Tres, this is because, “on the back of a yield hunt, non ILS funds have been the main buyers of these bonds and this has resulted in a return that did not meet our risk/reward expectations.”
Recently, the ratings agencies have revised their outlook for numerous life insurance markets as a result of the uncertainty and turmoil being caused by the coronavirus pandemic. In light of this, Artemis questioned Tres on whether this will impact the life ILS space in either a negative or positive way.
“Life ILS outlook is positive and that’s a function of different drivers: on one side the test investors are having on the asset class, on the other side the higher engagement we are seen already from the insurance community,” he explained.
Ultimately, he continued, investors have given Securis their funds to be invested in an asset class that delivers an attractive and uncorrelated return.
“If, despite investing in life risks in a context of our career’s worst pandemic crisis, the sector emerges substantially unscathed as everyone expects, well… I guess it’s mission accomplished.
“The big debate that life players had recently was: does it make sense to extend our remit to do insurance credit and potentially equity? There are obvious economies of scale on the origination side – which remains the only key growth engine of our industry. Think about the Tier 2 insurance market for example.
“Just to be clear, there is no correct answer here. Answers in the past have largely depended on the specific investors base that different funds have.
“Securis and other players have for instance opted for staying away completely from non-actuarial risks, either through the customized structuring or through hedging. Other have opted for other strategies: from cases where the asset risks were selectively chosen both from a risk and ALM matching standpoint to cases where funds seem to have taken unsecured debt, subordinated bonds or equity positions.
“Again, there is no right or wrong answer with any of these strategies, they are just different in risk/reward and behave differently in different market contexts,” said Tres.
For life insurers, the impact from the current crisis is expected to be threefold: a liability hit from greater mortality; an asset impact from market volatility and; an impact on sales volumes moving forward.
Expanding on these points, Tres started by noting that the higher mortality should not be material.
“The key impact area here is the asset side of the balance sheet. The “search for yield” has increased insurers and reinsurers’ credit sensitivity. Some analysts are focusing on insurers’ GIPS exposure. Reality is that most of the pain will probably come from BBB rated paper that risks the downgrade. The downgrade from IG to non-IG could lead to a rough doubling in capital charge for a given duration, even before default risk materializes in bond portfolios. Plus of course there is the area of synthetic asset guarantees that some smaller reinsurers seem to have extended on illiquid assets in the last few years.
“Just to clarify, I don’t expect that any of the large -or even medium size- insurers or reinsurers will have material capital issues. It’s however clear that both regulatory and rating capital are under more scrutiny. This is also very visible since some regulators are putting pressure on insurance companies not to pay dividends and to stop ongoing buyback programs.
“In this context it is natural that our customized derisking and financing solution tool aimed at providing insurance companies with a regulatory capital and/or financing benefit will find much more fertile ground than in the past,” explained Tres.
On a positive note, demand for life insurance is expected to increase significantly following the outbreak, added Tres.
“There is a massive protection gap in the word, it’s nothing new and plenty has been written on it. This outbreak will probably incentive people to increase their life/health insurance protection. We are already seeing this in China for instance, where insurers saw a massive increase of up to 80pc in life/health insurance sales.
“This increase in size will translate most likely to an increase in hedging requirements.”
As the crisis continues to unfold and businesses and entire industries adjust to the changing and challenging operating landscape, there will undoubtedly be winners and losers.
For Securis, Tres told Artemis that the current strategy and product offering puts the firm in a strong position despite current challenges and market volatility.
“The “product push” model didn’t work in our industry and, even more now, it will not take any life ILS fund anywhere. Being able to offer new value-added solutions to our counterparties is key. Off-the-shelves structures and public bonds purchases are not a viable strategy.
“To give you a ballpark reference, more than 90% of what we do at Securis is private, highly customized and direct to counterparties these days. Our business is broadly split in two areas: the financing business on one side and the innovative derisking solutions areas on the other.
“The first includes (among others) the more well-known embedded value and commission financing deals, a sizeable market segment that will be a clear winner in a context where traditional credit might not be as easy and cheap as in the past.
“The second one is the very innovative regulatory capital, solvency solutions and general highly customized derisking ideas that aim at providing a benefit to our (re)insurance counterparties in the specific framework they operate under. The higher attention to capital in general in the current capital market context will strengthen this business even more,” said Tres.