The work being undertaken in London, with the aim of making the city and its insurance and reinsurance hub a centre of excellence for insurance-linked securities (ILS), includes looking at developing ILS structures that would provide certainty in terms of equal credit for reinsurance and recovery.
It’s important to many cedants to be able to account correctly for their risk transfer, insurance or reinsurance, wanting to achieve credit for the risk transfer and ensure that this applies under the necessary regulatory environments and scenarios where it would matter to them.
With insurance-linked securities (ILS), including catastrophe bonds, private ILS deals, collateralised reinsurance, swaps and derivatives, it’s not always guaranteed to be the case that you can take full credit for the reinsurance and the recovery potential for an ILS, at least not without lengthy legal structuring and management fees.
So if London could develop an ILS structure, or amend the insurance and reinsurance regulatory regime, to enable automatic credit (or at least much easier credit) for reinsurance for ILS transactions completed in the financial hub, that could help it to attract some business to the city.
Ever since the work involving the London Market Group (LMG) and HM Treasury, to make London an attractive place for insurance-linked securities (ILS) business, began we’ve been saying it needs to thing bigger and bring something different to market.
Encouragingly it seems that there are discussions underway which hint at the way the LMG and its ILS working group may be looking to innovate.
At a recent event, Lloyd’s of London Director of Performance Tom Bolt hinted at how London and the LMG’s thinking on ILS is progressing.
Bolt explained that one of the issues with ILS uptake in many locations is that regulation threatens to curb their use and growth. This is something that London has been keen to avoid, hoping that any ILS initiatives in London are focused on smoothing regulatory burden and increasing speed to market.
Bolt said that London is keeping insurer and reinsurer cedants’ need to account for risk transfer at the heart of its thinking.
“Most of us have a score card, that relates to combined ratio, and we take credit for our hedges or assets protections on the liability side of the balance sheet,” he said, explaining the issue. “So if you don’t go through the operating income statement part of an insurance company, the management may feel they don’t get credit.”
He continued; “So even though the cat bond gains in value, or the derivative structure gains in value, it’s an asset side recovery, so you don’t get credit for it.”
So here London has found an opportunity to innovate and create an ILS structure or facility that would enable cedants to enter into ILS transactions, on a fully collateralised basis and backed by capital market investors, but with gaining credit for the risk transfer and reinsurance a much simpler, perhaps even automatic part of the transaction.
“One of the things we’re looking at is could you create a transformer vehicle, with the regulators’ agreement and support, in London, where you can take equal credit for reinsurance as you can for recovery under a bond, under an option, a swap, or something such as that, as long as it’s perfectly matched. So we’re talking to the powers that be about that, “Bolt said, explaining one of the specific angles that London is looking into
Now if a transformer or other ILS vehicle and structure can be created, in the London insurance and reinsurance market, which makes achieving full credit for risk transfer, reinsurance and recovery a simple process, with little to no additional legal or structuring overhead, it could be an extremely compelling reason to transact in the city.
That’s exactly the type of innovation that we’ve been saying London needs on ILS all along, daring to bring something different to the market which provides real-world and tangible benefits to ILS cedants and that could make it even simpler on the investor or capital provider side as well.
The LMG wouldn’t confirm the exact nature of the work being undertaken, but told Artemis; “This sort of thinking just shows that the work of the LMG task force is bringing to life the prospect of more ILS business being attracted to London. Players within our market are therefore looking at the implications of this for them and their business models. We are pleased at the impact LMG’s work is clearly having.”
If London can remove some of the hoops that cedants and investors have to go through in order to get the collateralised reinsurance product, or ILS such as catastrophe bonds, treated in the same way as a rated balance sheet transaction, then its efforts will be both worth it and likely rewarded with business wanting to be transacted in the city.
This kind of ‘regulatory smoothing’ is an area that London could really innovate and make a difference to the ILS market, offering something that just helps to make ILS market participants day-jobs easier. Granted, credit for reinsurance is not the biggest issue facing the market, it is already possible to gain credit for most ILS transactions using reinsurance trusts, but in terms of issues to smooth out it is a good start if the process can be made quicker, less onerous and of course cheaper.