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Longer durations & more UNL triggers the future of ILS: Paul Schultz


The tenure of catastrophe bond transactions will continue to be pushed forward alongside the increased use of indemnity protection through UNL triggers and, further convergence represents an opportunity to grow the overall reinsurance pie, according to Paul Schultz of Aon Securities.

One of the ways the insurance-liked securities (ILS) market has successfully differentiated itself from the traditional reinsurance sector is by offering multi-year capacity.

But it’s only a “matter of time passing by” before “I think at some point we’re going to go to seven, and at some point we’re going to go to ten, the duration of these bonds is going to increase over time,” said Paul Schultz, Chief Executive Officer (CEO) at insurance and reinsurance broker Aon’s investment banking unit, Aon Securities.

Further stressing that the increased tenure of deals will occur as the market continues to find ways of differentiating itself from the traditional market, which is now starting to offer multi-year capacity in an effort to compete with the ILS players and enhance their offerings.

Addressing an audience at a recent Insurance Institute of London (IIL) lecture at the Lloyd’s of London headquarters, Schultz discussed the growth of the ILS market and what it might look like in the future; with the increased tenure of transactions being something that he feels fairly confident will happen over time.

The growth of alternative reinsurance capital within the overall reinsurance industry has slowed in recent months, particularly when compared to the last couple of years, with its volume now estimated to be at around $68 billion.

Despite the notable slowing of capital within the sector, which will be welcomed news to those operating in the most competitive catastrophe exposed business lines, by the end of 2018 Schultz predicts the market to reach the $120 billion mark, “so we expect this to materially increase over the next 3 years,” he said.

As a percentage of overall reinsurance capacity, since 2012 the volume alternative reinsurance capital has basically doubled, explains Schultz, citing that going forward the opportunity is “really to grow the size of the opportunities for the reinsurance market as opposed to just moving marbles from one camp to the other.”

Which is essentially what has happened so far, as the glut of alternative capital has really taken capacity from one box in the market and put it into another, meaning that it “really hasn’t grown the (overall reinsurance) pie,” said Schultz.

The reason for the continued expansion of the market in recent times and the driver of its future growth are plentiful and include the ability to offer multi-year capacity, but Schultz states “the most important piece is the diversification.”

“Basically what’s happening here is we’re putting efficiency across a number of different platforms and providing capital, capacity to the marketplace, and that is the most important feature of why this continues in today’s world,” explained Schultz.

Later stressing that for investors, “low correlation to other asset strategies is a bedrock, founding principle for why investors want to invest in this asset class.”

As the ILS market and its participants, sponsors and investors alike, have become increasingly sophisticated and grown their understanding of the asset class, Schultz highlights some notable changes that have taken place and will likely continue to reshape the market moving forward.

Up from 12% previously, roughly 54% of the market is now transacted on a UNL (indemnity) basis, and Schultz feels that so long as the client wishes to trade in that way, at some point in the future “it’s going to be all UNL.”

“So the market is certainly growing in sophistication and where it’s going to support that,” added Schultz.

Currently around 80% of the ILS market is focused on U.S. perils, and Schultz expects this trend to continue moving forward.

However, it’s important to note here that perhaps on a longer time horizon, as modelling capabilities improve and the risk landscape shifts to emerging regions, ILS will increasingly find its way into underserved markets, like much of the Asia-Pacific.

But over the next few years at least, Schultz predicts U.S. perils to continue to dominate the catastrophe bond and wider ILS market issuance.

Another interesting observation Schultz highlighted during the lecture is the growing shift to an aggregate structure as opposed to per-occurrence, with aggregate deals increasing from 20% in 2010 to roughly 40% today.

“We see the aggregate component of this market growing over time, in a way it takes away the issue of reinstatement,” said Schultz.

Furthermore, primary insurers make up the majority of current outstanding ILS deals, and Schultz expects this to continue, as “they’re the bedrock foundation of this marketplace.”

Reinsurers’ issuance has been declining in the ILS space, but Schultz underlines that this is largely due to Swiss Re being less active in the sector in recent times.

Looking to the future Schultz expects a greater number of smaller clients to come into the frame, but feels market expansion will be driven by existing clients and a rise in government schemes, or catastrophe pools, and also expects the asset class to move into new business lines.

Again, and to conclude, Schultz expects the market to reach $120 billion by the end of 2018, stating “it’s going to happen by a shift into different perils, it’s going to happen by a growing of the pie and not just taking market share from one bit of the market to the other.”

Also read:

Pension funds investing direct to drive future ILS growth: Schultz.

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