Swiss Re Insurance-Linked Fund Management

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Some ILS funds continue to set small COVID business interruption reserves


A number of insurance-linked securities (ILS) funds have continued to report small increases in losses and reserves set related to business interruption claims from the Covid-19 pandemic, we understand, which continued to weigh on results over the last two months.

covid-business-interruptionClarity over the extent of business interruption losses that will be faced by the reinsurance market remains murky, which is resulting in a slow drip of reserve setting by ILS funds and capital market vehicles, as managers make best efforts to ensure any potential future impacts are accounted for as fully as possible now.

The ILS fund market has been setting side pockets and reserves for potential exposure to the COVID-19 coronavirus pandemic since as long ago as March 2020, with many ILS managers having proactively taken steps to segregate positions that were expected to face losses.

But the business interruption situation is constantly moving, with some notifications having begun from reinsurance programs over the last few months, causing additional reserving, while other factors such as the UK’s test case appeal decision also potentially set to send further business interruption claims towards reinsurance layers.

We understand that some further reserving actions were taken in December and that there could be more visible in ILS fund results in January as well, although again these aren’t particularly significant overall.

They may be sufficient to erode monthly performance for some ILS funds, we’re told.

But still, the consensus remains that, overall, the business interruption hit to ILS funds and vehicles is expected to be minimal in the majority of cases.

We understand that some quota share structures continue to be a source of actual business interruption attritional (small) losses, with potential ramifications for some reinsurance sidecars and similar vehicles.

COVID-19 business interruption exposure has been denting ILS fund returns for some months now, with reserving actions seen in both October and November.

With more actions in December 2020, COVID has been eroding the return of some ILS funds, but as many of these actions are reserving and side pocketing and uncertainty remains over actual losses, there is the potential a portion of this is returned to funds in future.

A report had suggested that some higher-risk insurance-linked securities (ILS) and collateralised reinsurance funds have been forced to reserve more than 4% of their fund assets in case of losses from business interruption claims caused by the COVID-19 pandemic.

In some cases now, a few months further on, there could be some ILS funds with larger reserves set aside, but it’s hard to know for certain.

The considerably uncertainty over how COVID-19 business interruption claims will aggregate, how arbitration may play out for some reinsurance layers, and what in the way of claims will actually flow through to ILS funds means managers are having to be as proactive as possible to protect investors.

We understand that most of the recent business interruption reserving seen in the ILS market has been related to European reinsurance programs.

There is still a lot of uncertainty over U.S. programs, we understand, but insufficient clarity exists to take further reserving actions beyond those taken much earlier in the pandemic.

In speaking to ILS fund managers lately, the majority express confidence in how they have reserved from the start and do not expect any surprises to come from COVID-19, unless of course there is an impactful legal decision that changes things dramatically.

But they do warn of the potential for attritional losses as they set reserves, trying to cover uncertainty and ensure their investors are well-protected.

As a result, it seems the impacts of COVID-19 will continue to flow, although lessen as property policies increasingly run their terms and so gradually the exposure to in-force coverage lessens.

At which point it may become a waiting game for greater clarity over the eventual legal situation and any arbitration activity over reinsurance claims that takes place.

Of course the other issue waiting to play out is related to fresh trapping of ILS and collateralized reinsurance capital by cedents looking to cover potential claims they may face further down the line.

As we explained, this issue was largely postponed until after the January renewals and some discussions on this are likely underway at this time.

At this stage there remains little clarity over the potential impacts of trapped capital due to the pandemic, but still, as we explained, the thinking is that the trapped collateral issue won’t be as significant as had previously been thought, for the ILS market as a whole. Although for certain strategies it could turn out to be more impactful than others.

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