The past few months have provided unprecedented challenges for all areas of the global financial markets, but for insurance-linked securities (ILS) players, the ongoing desire for un-correlated assets presents a great opportunity, according to industry experts.
On the final day of our virtual ILS Asia 2020 conference, leaders and experts from across the ILS and reinsurance sectors discussed the current state of the ILS market and the importance of capital efficiency.
The panel discussion, which is available to view in full on-demand here, featured: Andrew Hughes, Managing Principal, Hiscox ILS; John Doucette, President and CEO, Reinsurance, Everest Re Group, Ltd.; Michael Stahel, Partner/Portfolio Manager, LGT ILS Partners Ltd.; and, Michael Millette, Founder & Managing Partner, Hudson Structured Capital Management.
One element of the marketplace that was debated by the panel was correlation, and the fact that, owing to the severity and reach of the financial implications and stress of the Covid-19 pandemic, investors in the space are asking more questions about correlation.
“There’s been a lot more conversations from ILS investors about correlation,” said Doucette. “And, you think back to 2008, there was kind of a proven data point that there wasn’t, with the cat bonds being one of the only capital markets that was still in effect and wasn’t frozen.
“And, I think there is an open question now from some of the capital markets as to whether there is correlation, what does that mean, because as it effects everything. So, I think that has resulted in a lot more uncertainty, a lot more questions and concerns, not just because of that but also because of the overall decrease in capital that we’ve seen.
“I think what it’s going to result in is some of the tourists, some of the people that were just dipping their toe in, I think will continue to retreat, and I think that’s just the natural evolution of this.”
Expanding on this, Millette stressed that while investors are certainly interested in the space, they are wary.
“Investors are interested because of what John Doucette referred to, correlation in capital markets has always been an issue and it has been an increasing issue. In the financial crisis it took about a year for the crash in the mortgage and structured finance business to spread into and affect the equity markets. This past first-quarter it took about two weeks for the crashes to spread from equities to credit to structured finance, to every other sector of the global financial markets. That was terrifying. The case for diversification and non-correlation is stronger than it’s ever been.”
However, according to Millette, the ILS sector must confront two problems that are currently having a negative impact, including the fact that the market wasn’t free from correlation during the recent financial market turmoil.
“Through the vehicle of business interruption and the potential for business interruption losses to wander into the catastrophe space, investors found themselves, even in their ILS portfolios, having to think through the implications of the global financial crisis, and having it be maddeningly uncertain.
“We now are witnessing this jousting match between the FCA and companies going on in London, and between plaintiffs’ law firms and companies in the United States, and that’s going to go on for a period of time.
“The second reason for investor wariness, is the Velcro like quality of the cat sector to attract and multiply its losses in almost every event since 2017.
“So, these are challenges for the sector, the sector is going to need to think more carefully about correlation and one of the ways is getting back to a tighter named peril discipline. The industry is going to think about trapped capital, and it is going to need to think about alignment. Alignment has slipped in the balmy years between Wilma and Harvey, the premise and principals supporting alignment, between cedants and reinsurers, slipped in the reinsurance sector, and those mechanisms are going to need to be reasserted.
“At the same time, what a great opportunity. Investors need non-correlated assets, these are some of the best, substantially sized non-correlated assets available on earth, if only they can be structured properly,” said Millette.
Another topic explored early on in the discussion focused on the ability of ILS participants to raise capital, a trend that has gained momentum in the traditional reinsurance market as players look to capitalise on the firming market landscape.
“It was rather difficult to discuss prospect investments with investors over the period of the real coronavirus crisis, especially in Europe, and now again in the U.S. So, you obviously could not travel, you could not meet counterparties, potential investors, and also, on their end, they are working from home, it was difficult for them to meet in committees and teams to decide on either an initial allocation, or an increase,” explained Stahel.
He continued to note that on the increase side things are much simpler as due diligence has already been completed and, at LGT, this an area where the firm has had some recent success and is quite positive in its ability to raise even more capital towards year-end for the Jan 1st, 2021 renewals.
“However, I have to admit that it’s becoming a bit more complex, a bit more complicated, given the coronavirus situation,” said Stahel. “I have to admit, I’m a bit more positive towards year-end if I look at our pipeline that we’ve lined up, I think this is going well. The only question then is, what will the market be like at the end of the year, we just hope that the opportunity will still persist and hopefully into 2021.”
Hughes of Hiscox ILS agreed that there’s definitely investor interest, alluding to an earlier panel at the event in which institutional investors that allocate to the space noted a desire to expand their allocations.
“So, there’s definitely interest from existing and there’s certainly now interest from new entrants.
“I think it is quite interesting to see where the capital is coming from, certain markets seem to have contracted a bit, quota share capacity and alike is rumoured to be contracting. But, on the other side, you have private equity coming in, who are maybe thinking about not necessarily setting up a new vehicle or backing a management team, but actually going into a sort of partnership model, going to an established player so they don’t take any of the execution risk on establishing a new venture,” said Hughes.
As well as the on-demand playback, we will be archiving every session from our online and virtual ILS Asia 2020 conference over on our YouTube Channel in the coming weeks.
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