Lloyd’s of London has published a vision of insurance-linked securities (ILS) investments being made available through a digital system where investors can specify their own risk, return and other requirements.
Yesterday, the Lloyd’s insurance and reinsurance market published its awaited prospectus, representing a brave new strategic direction, with six key initiatives floated, one of which is enabling more flexible and simple access to the market’s risk-linked returns for capital providers.
Details are of course scarce, as the insurance and reinsurance market’s CEO John Neal said that a consultation period would be held to gain feedback from participants, after which prototype’s created and any quick-wins fast-tracked.
But realistically, Neal said prototypes should begin to be expected in October 2019, with some potentially operational in early 2020.
However, what Lloyd’s did provide was a vision of how an institutional investor could interact with and attach its capital to risks in the Lloyd’s market.
This brave new world, laid out in the form of a story, suggests a desire for digitalisation to live at the heart of efforts to make it simpler for capital to access risk.
But before you get excited about the potential for robo-advisors enabling you to transfer money into customised funds made of up your specified Lloyd’s market risks, it’s important to put it into context with some of CEO Neal’s words from the Future of Lloyd’s event yesterday.
Neal explained that the vision would, “Allow investors to access new types of insurance risk and would provide market performance data, enabling better investment decision making and different risk return appetites to be satisfied.”
He explained that options to access risk-linked returns from the Lloyd’s market could entail structures such as a Lloyd’s market tracker (something that’s been discussed in detail over the years), as approved follow capacity to a market lead, or other ways as yet to be envisaged.
Neal then said that, “Investor appetites could be defined on a digital platform,” including such factors as returns, risk type and territory of risks invested in.
These are radical ideas for a radical reforming of the Lloyd’s marketplace, that’s for certain, although “digitalisation” is an angle that the Corporation was almost destined to add to every one of its reform ideas.
But the devil is in the detail here, as there is a world of difference between following the market by investing in a tracker fund, or following a lead underwriter’s deployment choices, both of which put you as complementary capacity (that likely has to be the cheapest), over being able to slice and dice the risks and returns of the market through your own digital access point.
It’s a sign that the vision isn’t yet fully formed, as Neal had explained, with the stories of each initiative or idea reading like a persona would in the design and user experience world.
Hence they provide a useful thought piece for those involved in working out the nuances and details to begin from, so the end-result may differ wildly from these starting points.
The story, or persona of an investor allocating to a “future Lloyd’s” explains that “Lloyd’s has created the go-to place for capital to invest in insurance risks, and a wealth of new investment opportunities for investors like me. It has made it possible to invest easily and efficiently in different types of insurance linked products beyond property cat, without needing to be a licensed insurance-linked entity or having to invest in a typical insurance company.
“This allows me to access several new types of insurance risk, as well as different options for attaching my capital to risk, each with different risk-return expectations and different investment time horizons. In addition, it provides market performance data, and hence performance transparency, enabling better investment decisions.”
It goes on to say that Lloyd’s will continue to create more routes to access risk, as a Lloyd’s tracker and following a lead capacity provider, are neither really providing much in the way of options for investors, or leaving much room for alpha to be generated.
But the important area of risk and return appetite is addressed, as the theoretical Lloyd’s market ILS investor says they can, “Define my investment appetite through detailed parameters. I set them in the system, including my return expectation and risk tolerance, the carriers I am willing to follow, and the types of risk and territories
I’m interested in.”
These parameters are then matched with market participants for the investor to follow and those carriers can allocate to individual risks or portfolios using the investors capital.
You’d imagine the investors may want to see historical performance for these underwriting shops, full details of their underwriting processes and team backgrounds, before allowing them the keys to their capital.
Hence, if Lloyd’s is to provide such a digital front-end to allow ILS investor style access to the market, it’s really going to have to be based on the utmost transparency and allow granular comparisons to be made between underwriters.
How the lesser performing syndicates and underwriters within them might feel at this stage, when their performance is laid bare for everyone to see, remains to be seen.
But this would be something that might drive a performance based culture at Lloyd’s, however that doesn’t always sit so well in the subscription and following market paradigm we see today (suggesting, to us, greater changes to come).
The imaginary investor also said they can allocate and invest directly in Lloyd’s created portfolios that back a particular class of risk.
Now that sounds like Lloyd’s itself as ILS investment manager, designing mandates for investors and managing their exposure for them.
Can a marketplace operating corporation also manage capital for investors, selecting risks and markets to back? Or is the conflict there far too great, in the current Lloyd’s market construct?
Automated capital release looks set to be a key feature, which could be a huge benefit to some investor styles.
“The amount of capital I need to hold at Lloyd’s is calculated and released back to my account as the outcomes become known and the risks mature, and it’s easy to value my investments. Lloyd’s capital efficiency means that I need to deploy less capital than if I sought the same exposure to insurance risk elsewhere,” the investor persona explains.
Lloyd’s also might help syndicates better manage their capital as well, as the analytics it might gain from investor selections could be used to help syndicates identify how much third-party capital they need, versus capital they hold themselves.
This does seem to suggest Lloyd’s itself holding the keys to the data flow in the market, which is where significant future value can be created, but which could put it into loggerheads with brokers and others who are also trying to control the market’s data and provide it back to clients as paid service provision.
Of course a secondary market is also described, as investors may want to sell on risk exposures to others in the marketplace.
How valuations would be made isn’t explained, but we’d suggest this isn’t a job for Lloyd’s itself anyway.
The investor’s persona finally says, “It’s good for the Lloyd’s market, too: syndicates are now writing larger lines of risk with the easily accessible capital.”
That really should be the driving rationale behind all of this of course, the needs of the market participants and their clients, ultimately right down to the policyholder.
If allowing flexible and efficient capital access, through digital or other means, can help to drive down the cost of coverage, reduce intermediation expense and increase transparency, then these ideas are precisely where the focus should be at Lloyd’s.
CEO of Lloyd’s John Neal explained why this work is so important to the market, saying that alternative capital has grown into an important piece of the industry and also served to increase rate competition in recent years, which he called “a good outcome for the customer.”
But, “As a capital dependent industry, we’ve got to make it easier for alternative capital to attach to risk, thereby providing better client value,” he stressed the importance of becoming more open to ILS and third-party reinsurance capital.
The fickle minded might offer though, that once you open the gates to the efficient capital hordes you may only encourage more rapid modernisation to occur. Leading to an inability to remain in control as the gatekeeper, so allowing risk to escape from the Lloyd’s market construct more frequently and efficiently as well.
Therein lies the challenge of market modernisation.
Eventually you could increase the efficiency of matching risk and capital so much, and introduce so many digital channels of communication and transaction, that the market itself becomes ineffective and unnecessary, leading to the potential for a slow (or even rapid) decline.
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