Schroder Secquaero takes proactive approach to fair value under COVID-19

Schroder Secquaero, the specialist insurance-linked securities (ILS) unit of global asset manager Schroders, has taken a proactive approach to fair valuation of its ILS funds under the shadow of the COVID-19 pandemic.

COVID-19 and the coronavirus raised a new and significant uncertainty for ILS fund valuation, as there is potential exposure to business interruption claims from certain property policies.

However, given the way the pandemic has developed and the legal action over business interruption wordings, plus differences in wordings and clauses from one reinsurance contract to the next, working out exactly where losses may fall has proved to be quite challenging for the ILS sector.

Schroder Secquaero has adopted its typical fair valuation approach to this and decided from the early days of the pandemic that being proactive was key, so that its investors could be both forewarned of any potential losses to its ILS fund, as well as kept informed.

Speaking with Artemis in an interview, Christoph Hummel, Head of Analytics at Schroder Secquaero explained the need to get ahead of the developing pandemic situation early on.

“We take a very proactive approach in case of uncertainties,” he explained.

Adding that, “If the likelihood that collateral on a non-transferable instruments would be trapped at the end of the risk period increases due to an event during the risk period, a fair value adjustment is already appropriate, even if the likelihood of a loss to the instrument is unlikely at that stage.”

“Schroders, with its institutional set-up, requires fair valuation with proper governance from day one when they had acquired the first stake in Schroder Secquaero,” Hummel continued.

He explained that the company has a team of actuaries and catastrophe risk modellers who between them conduct a monthly analysis of positions in the Schroder Secquaero ILS funds, with many of this team having been at the firm when Schroders bought into the ILS specialist unit.

The company is proud to have experienced “limited adverse loss developments over the last few years,” Hummel said, which he puts down to taking this proactive approach to fair value and taking best effort to avoid unnecessary surprises for investors. “As time goes by and more information about an event is gained, loss estimates usually move. However, over time there should be no significant bias in the movements in either direction.”

“This and our open communication is well received by our investors,” Hummel said.

In the case of the COVID-19 pandemic, a proactive approach to establishing fair value has become even more important.

Hummel said that, “Based on the public discussions in April 2020, a fair value assessment of ILS transactions potentially covering business interruption (BI) was inevitable.”

“You didn’t even need to know for sure if there would be a loss. The uncertainty about the outcome and the public discussion around BI claims in particular implied that one had to put a price tag to that uncertainty under fair value requirement at the latest in April.

“At Schroder Secquaero, we did a thorough review of all treaty wordings. Based on public information and discussions with some cedents, we derived scenarios for the range of potential outcomes. They form the basis for actuarial assumptions in the valuation leading to adjustments from Covid-19.”

He went on to explain that actuarial assumptions do have to be made, especially in cases where the potential loss event situation is ongoing and developing, such as with a pandemic.

Assumptions can be derived from a range of information sources, including the ceding company, Schroder Secquaero’s own experience, or that of a third-party, as well as publicly available and industry specific information.

Importantly though, “You do not wait for the cedent’s accounts before making any adjustments,” Hummel said.

In many cases, a cedent may not officially report a loss to a reinsurance contract for some months and for a retrocessional reinsurance contract it can be even longer, but it’s vital to establish fair value sooner for the good of investors in the ILS fund, Hummel explained.

Adopting this proactive and fair value approach means that no investor is treated preferentially when investors are trading in or out of the fund, while any valuation adjustments are also reviewed on a monthly basis by an independent 3rd party actuarial consultancy.

Staying ahead of the valuation trends by proactively adjusting fair value based on informed analysis and modelling means that investors have a more realistic picture of any loss situation and can therefore make better informed decisions about their own investment allocations.

Under the shadow of an unprecedented pandemic such as COVID-19, this fair value approach to ILS fund management is more important than ever.