The collateralised reinsurance sidecar market and private quota share transactions entered into by insurance-linked securities (ILS) funds and investors may face the highest impacts from Covid-19 pandemic related claims, A.M. Best has said.
We’ve been raising the subject of sidecar and quota share ILS market and investor exposure to claims from the Covid-19 coronavirus pandemic since the beginning of April.
With quota share arrangements often seeing the reinsurance or retrocessional capital provider, be that an ILS fund, an investor, or a traditional reinsurer, following the fortunes of a property book of business and in many cases not restricted to only covering losses from named perils, the sidecar and private quota share segment was always an area to watch for potential claims leakage to ILS investors from the pandemic.
Rating agency A.M. Best warns that, “The sidecar market generally will face a relatively higher impact on claims activity from COVID-19.”
Collateralised reinsurance participation in programs will take some losses of course, but largely only where it either should have covered a line of business that has taken claims from the pandemic, or where wordings and exclusions have proven to be insufficient to protect the cedent against claims, or finally where legal action has forced a claim through (again likely due to insufficiency of wordings).
Catastrophe bonds meanwhile won’t take any losses beyond the World Bank’s pandemic cat bonds, that have already been triggered, as the majority are providing their reinsurance coverage on a named peril basis and the cat bonds covering mortality and health insurance risks would likely require a much more significant mortality and claims rate to emerge, which now seems unlikely from this specific outbreak.
Elsewhere in the ILS market, instruments such as industry loss warranties (ILW’s) are seen as unlikely to face any pandemic claims impact, as they cover named catastrophe perils and the third-party data providers who report industry losses would be unlikely to factor pandemic claims into any qualifying cat event.
So there is a growing likelihood that the quota share could be the source of the main impact for the ILS market and its investors, given the pro-rata sharing of losses between cedent and protection provider.
Something A.M. Best highlighted saying, “Some sidecar investment vehicles that follow the fortunes of a reinsurer on a quota share basis could be exposed to business interruption claims due to the COVID-19 pandemic.”
Quota shares and sidecars may also cover property towers that lack exclusions, allowing claims to flow through to the reinsurance or retrocessional capital backing them.
“The quota share sidecar could see more claims activity, leading to capacity constraints in the retro segment of this market,” A.M. Best also warned. But qualified this saying, “Overall impact, however, may be limited given the low sublimit for business interruption coverage.”
It will be interesting to see how losses could flow into some of the most established collateralised reinsurance sidecar vehicles, such as those from major global reinsurers Hannover Re, Munich Re and Swiss Re.
All have quota share vehicles, but Hannover Re’s in particular has in the past covered a slice of its speciality lines business as well as natural catastrophe exposures, perhaps making it a little more open to Covid-19 claims as a result. It’s hard to be certain though without seeing the full terms and underlying risks.
While the quota shares from other reinsurers are more catastrophe focused, but could take shares of losses as claims flow into major property insurance towers, triggering reinsurance coverage and ultimately sending a share of claims down the line to ILS investors through quota share arrangements.
Reinsurance broker Willis Re had highlighted the risks to sidecars and quota shares as well and warned that any further dent to investor confidence in these structures could push some to look to the catastrophe bond as a more risk-remote, well documented source of insurance-linked returns.
“Whether the COVID-19-related BI losses will impact the sidecar market or not will meaningfully impact investors’ long- term confidence in the product — and there are real worries on the part of investors of this possibility,” the broker had said.
There are some sidecars in the market that take a quota share of a primary book of property insurance business and these could be the first to face exposure as a result, given they are closer to the source of claims.
Market facing reinsurance sidecars, where risk is more actively selected, may only be exposed on a contract wording, case-by-case basis.
While retro sidecars, supporting major reinsurers, could find it takes months for any exposure to become fully clear, as the reinsurers first need to see loss notifications from their clients, then establish whether their own losses will rise to a level where the sidecar coverage capital could come into play.
Meaning investors in sidecars and quota shares may have to wait a while longer for any exposure to become clear. A different situation to certain collateralised excess-of-loss contracts, which ILS funds have already been able to mark down.