No reason ILS can’t expand to energy all-risk property coverage: Willis

As capital market investors increasingly looks to insurance risks as an asset class, there is no reason that ILS structures couldn’t be expanded to provide energy all-risk property coverage, according to insurance and reinsurance broker Willis Group.

With the insurance-linked securities (ILS) market growing and the amount of third-party, or alternative, capital utilised in both reinsurance and insurance markets increasing, it stands to reason that property risks faced by energy and natural resource companies will be a target for capital market investors.

Some ILS fund managers already provide capacity for some energy reinsurance covers, although largely restricted to natural catastrophe exposures to date. Some specialty energy risks are becoming absorbed into certain ILS funds, but the opportunities for investors to access this area of the insurance market as a diversifier remain relatively limited to date as ILS focuses on property catastrophe risks still.

As risk models improve and initiatives such as indices to measure and report industry losses progress it is expected that the amount of capital markets capacity devoted to energy risks will grow.

Willis discusses this within its latest Natural Resources Market Review, explaining that as captive-type insurance structures have become funded by capital market investors, through the use of special purpose vehicles, it may only be a matter of time until the energy sector seeks to tap into this trend.

“Subject to modelling capabilities, there is no reason why the range of risks could not be extended to a basket of all risk property protection,” the report explains.

“It is quite possible that in the near future it will become more common for energy companies to access (re)insurance protection from the capital markets via their own captive directly, or buy collateralized reinsurance from an SPV or cell company.”

This would be another direct intervention by the capital markets and ILS investors, which could result in new risks becoming available to the market which have historically not been traditionally insured, like many energy captives, and could remove risk from the reach of traditional reinsurers.

Willis notes that for ILS and capital market investors to become comfortable providing capacity directly to energy corporates the investors will need to be comfortable with their being no commercial insurance carrier to settle claims.

That could require a third-party claims administrator to come in on any such deal. However, if a major energy company decided it wanted to fully fund part of its captive all-risks property exposures we are sure that ILS and capital markets investors would find a way to bring the right service providers into the transaction.

In order for energy companies to look more seriously at the ILS and capital markets, Willis suggests that the coverage would need to be more all-encompassing.

“The cover will become more useful if it expands beyond well modelled named perils (natural catastrophe risk) to include the broader coverage found in an all risk cover,” the broker explains.

Willis highlights energy sector cyber liabilities as another area where alternative capital could be put to good use, as there is insufficient traditional capacity to cover these risks.

The broker said; “It is generally accepted that there is insufficient capacity in the market to cover a major loss, so this is an obvious area where existing and alternative capital could be harnessed to drive a more significant and buyer-friendly solution.”

Overall the excess capital in the traditional and alternative reinsurance markets is driving down energy and natural resource sector rates. These risks are commercial, large and often property related, making them a natural target area for ILS players looking to expand and diversify into specialty classes.

Willis explains the market pressures; “These heavily over-capitalised global reinsurance markets, combined with a glut of new capacity from non-traditional providers, have naturally increased competitive pressures in the direct Energy insurance markets like never before, with Upstream and Downstream market capacity levels now at approximately USD7 billion and USD5.5 billon respectively.”

Capacity causes price pressure and in the energy space this is more apparent than many classes of business. Willis continued; “Regardless of market conditions, capital needs feeding. So long as overall capacities increase, so will competitive pressures, at least in the long term. Some might suggest that a significant amount of this capacity is not realistically accessible on a day to day basis, and there is some merit in that view. However, with the exception of the few years after hurricane Ike we have always found a correlation between increased capacity and lower prices.”

And of course, at the same time as alternative capital begins entering the space, traditional players look to sectors such as energy, mining and natural resources for a way to avoid the competition in other core markets.

“Reinsurers, who themselves are under intense competition from alternative capital suppliers, are throwing additional capacity in to the Property market and the Mining sector is not immune from this positive trend,” Willis said.

As risk modelling continues to improve in these sectors, and ILS managers familiarity with energy risks grow, we can expect an increasing amount of ILS capital will target the natural resources and energy space.

It will take time for the sector to become fully open to ILS, but if energy companies come under additional pressure to better financial protect themselves against disasters in the future, rather than self-funding captives, that could be a huge opportunity for ILS capital to take a significant chunk of this market.

At the very least we can expect to see increased participation from ILS and capital markets players in the form of collateralized energy reinsurance. At the other end of the scale we could see energy players looking to turn captives into fully funded sidecar type vehicles.

Between these two extremes there is definitely scope for more ILS growth.