Swiss Re Insurance-Linked Fund Management

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Munich Re’s Jeworrek questions ILS’ increasing use of leverage


During reinsurer Munich Re’s recent earnings call Chief Executive Officer (CEO) of Reinsurance, Torsten Jeworrek, questioned the increasing use of leverage in the insurance-linked securities (ILS), or alternative capital business model and subsequent potential credit risk for reinsurers.

Specifically, Jeworrek highlighted that in today’s marketplace the wealth of alternative reinsurance capital players no longer fully-collateralised as they once did, with ILS business models increasingly using leverage.

As an example, he highlighted ten different catastrophe events that can be put together, but stressed that not ten times the limit is collateralised anymore, with this falling to maybe only four or five times the limit.

Jeworrek states that the more hedge funds, pension funds and alike aren’t required to provide 100% collateralisation for all the limits they offer, the more that this type of reinsurance is likely to fail, essentially driving credit risk.

ILS participants are working more and more with fronting companies or rated entities that allows for leverage with collateral behind it. And we would question whether leveraging underwriting with partial collateral that has cash (or equivalent) behind it, is in factany more or less risky than leveraging underwriting with a portion of a balance sheet behind it, an approach practiced by reinsurers.

Typically, when using a fronting arrangement or accessing the market via a rated entity, the credit risk is held by the reinsurer, which, could well be a player like Munich Re, or any of the other large players.

Jeworrek questions if regulators will continue to accept limits that aren’t fully-collateralised in the same sense as they were in the past, or whether it could be penalised, resulting in an uneven playing field.

“Which means the traditional reinsurer who were strongly monitored and regulated and also reported as really expensive and a burden for our industry, and on the other hand you have very lean pension and hedge funds who don’t have to provide the same amount of capital for the same risk,” said Jeworrek.

Fronting arrangements, as seen with State National Companies and Nephila Capital, the largest ILS fund manager in the world, enable ILS participants to access risk more efficiently and outside of the typical reinsurance cycle, something that has become increasingly attractive in the softening market.

Such relationships benefit both the ILS party and the fronting company, providing the latter with increased revenue from fees and similar while on business underwritten using a third-parties capital.

The ILS business model continues to evolve, as does the traditional model, and it’s apparent that the convergence between them is intensifying, and it’s increasingly difficult to tell them apart. With both parties looking to work with each other to increase revenue, efficiency, and relevance during testing market times.

Of course major reinsurance firms like Munich Re also provide ILS funds with leverage in a way and earn fees from this work, making the comments perhaps even more interesting in the currently competitive market climate.

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