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The “horizontalization” of ILS to intensify in 2017 & beyond: JLTCM


Following a wave of verticalization in 2016 the insurance-linked securities (ILS) space in the coming months will be defined by horizontalization, being the expansion of the ILS product offering, say Rick Miller and Michael Popkin, Co-heads of ILS at Jardine Lloyd Thompson Capital Markets (JLTCM).

Jardine Lloyd Thompson Capital Markets Inc.In a recent interview with Artemis, Rick Miller and Michael Popkin of JLTCM, the capital markets division of insurance and reinsurance brokerage JLT, discussed the ILS space during 2016 and what developments the market might undergo in the coming months, with the horizontalization of the ILS marketplace a consistent theme.

“JLTCM believes that 2017 will be characterized by ‘horizontalization,’ or the persistent expansion of ILS into other areas of insurance and reinsurance risk transfer. During 2016, we witnessed a continued wave of verticalization, with ILS managers moving upstream into offering traditional catastrophe protection to a typical buyer of insurance (as opposed to reinsurance or retrocession).

“Horizontalization is defined as the broadening of product offering (e.g. weather derivative, casualty, closed block life deals, motor pool, surety, etc.) to any participant on the risk transfer spectrum,” explained Miller.

Artemis discussed a number of times throughout last year how ILS capacity was increasingly looking to access the original source of risk more directly, ultimately jumping the risk transfer value chain in search of efficiency and the potential for higher returns.

And while the trend of verticalization is expected to continue in 2017, Miller and Popkin believe that the expansion of ILS into new product lines will be a key focus of the space in the months ahead.

“We observed some early steps in this direction in 2016. For example, JLTCM completed the first weather cat bond (Market Re 2016-5) in nearly two decades. The weather deal still had the uncorrelated elements to it, i.e. the weather in Europe doesn’t become warmer or colder based upon macro events like Brexit.

“Investors who were looking for diversification and yield liked the transaction because it gave them access to a security that had both different risks and a higher coupon than other outstanding European cat bonds. We expect to see more of these types of opportunities,” continued Miller.

Adding; “Other manifestations of the horizontalization will be the greater movement into life deals and regulatory transactions like Solvency II relief. To date, we have only seen some of these transactions although the number of ILS managers who have experts and funds for these areas has grown.”

As shown by the Artemis Deal Directory, the $30.75 million Market Re 2016-5 catastrophe bond transaction was just the second time in the market’s history that temperature risk has featured, and it’s innovative issuances such as this, and into other business lines outside of weather risk, for example, that JLTCM expects to grow in 2017.

Popkin explained to Artemis what the cause of increased horizontalization might be; “In a world of macro uncertainty, upstream investors continue to like the uncorrelated nature of ILS risk. Moreover, as ILS has moved from infancy into a more mature phase (to be clear, it is still not a mature market); ILS managers have expanded their teams, their models, their underwriting, and their overall knowledge base. Furthermore, they have expanded not only AUM but also the scope and flexibility of their funds. Most can now transact comfortably in collateralized reinsurance formats as well as in pure bonds.

“Private placement cat bonds, like those that JLTCM has been a leader in, have become widely accepted, which allows for more customized risk. Nevertheless, we are still in a marketplace that has more money (i.e. risk capacity) than risk being transferred. In response, ILS has expanded across the reinsurance tower as well as into insurance itself. The continued verticalization and the increasing horizontalization reflect the growing skills sets of ILS managers as well as the overall acceptance of the ILS asset class. We will see more deals like the weather cat bond, which will transfer a wider variety of ILS risks,” said Popkin.

The pair continued to tell Artemis that sustained horizontalization would also be seen with business interruption (BI) lines, contingent business interruption (CBI) lines, and also community interruption (CI) coverage in 2017, with the heightened sophistication and assets under management (AuM) of ILS managers placing them in a better position to develop the right solutions for corporates.

“As corporates (and the equity analysts who follow them) begin to recognize the potential to shift these risks off of their balance sheets and the ability to do so in size, they will transfer more risk to ILS managers. For example, there is no reason for a public company to have an earnings miss due to BI, CBI, or CI related to cat or weather risk when they could have transferred these risks to the ILS markets,” explained Miller.

“Equity investors want companies to maximize profits and transfer known risks, such as FX or interest rate. Companies who don’t transfer FX or interest rate risk get punished by hits to their market cap. Similarly, to the extent that the broader investor universe begins to understand that companies don’t need to warehouse BI, CBI, and CI related to cat risk, they will hopefully reward those corporates who wisely transfer to better holders of the risk (e.g. ILS funds) and be critical of those who don’t. This will happen in stages, but we expect to see more of it in 2017 as horizontalization moves in a variety of directions to seek out more (appropriate) risk adjusted returns for ILS risk,” added Popkin.

It will be very interesting to see if deals such as Market Re 2016-5 drives further innovation around weather bonds and alike in the coming months. With investors and sponsors in the ILS space seemingly willing and able to assume more and more insurance and reinsurance linked business, the potential for ILS features and capacity to expand and broaden in terms of geographies and perils is very apparent.

“A famous innovator supposedly once said, “Visions without execution are hallucinations.” With deals such as the Market Re Weather bond, we have already seen the first steps of horizontalization. It will still take, among other things, new mandates and new structures to continue and broaden these early developments.

“However, it was not long ago that ILS managers were a sideshow and convergence a much debated topic. Today, alternative capital is integral to our sector and convergence a given,” concluded Miller.

Read previous Artemis interviews here.

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