In the latest in our series of interviews with figures from the risk transfer and insurance-linked securities (ILS) and reinsurance markets, at Monte Carlo Reinsurance Rendezvous 2016, Artemis spoke with Bill Dubinsky, Managing Director & Head of ILS at Willis Capital Markets & Advisory (WCMA).
Bill Dubinsky serves as MD and heads up ILS at the WCMA unit, which is the catastrophe bond, insurance-linked securities and capital markets specialist team at advisor, insurance and reinsurance broker Willis Towers Watson.
We discussed the importance of transparency and liquidity in the ILS market, the need for investors to understand the limits of modelling and how the ILS sector might react after the next major loss event.
To begin, how do you think both the ILS and reinsurance market will react after the next major loss event occurs?
It really depends on the type of event and how well it was anticipated by the models. If we wake up tomorrow and suffer $100 billion in insured losses from an earthquake on the San Andreas Fault, ILS investors may show up with fresh capital even more rapidly than reinsurance equity investors. Insolvencies and downgrades could pose trouble for some reinsurers as well, especially where they have aggregation risk across lines. On the other hand, ILS investors could invest quickly across the board (sidecars, private ILS, widely distributed ILS, contingent capital) in response to modest upticks in rates and investment returns. There is a lot of ILS capital in “ready to go” mode.
If the source of loss is largely outside the models (or the contract terms), all bets are off. Many ILS investors and the pensions and others backing them do not expect to lose half their money from say a London volcano producing 100 billion pounds of insured losses. If something like that happened, ILS investor activity is less predictable. Some would pull back but others might double down. An event like that might also cause considerable turmoil with some reinsurers and their equity investors too.
As the ILS asset class grows is there a danger that some investors may not truly understand that risk modelling is not an exact science and the models can only be directional?
That absolutely is a risk, especially if the investor base continues to diverge from the model of ILS funds backed by sophisticated pensions and endowments. The key is to match investment suitability with the actual investors. Should retail investors be investing directly in indemnity property insurance covers for individual multinationals with unscheduled property and substantial contingent business interruption exposures? Maybe not . . . it is tough to see how that would work. Could those same retail investors back a proportional structure behind a leading insurer or reinsurer with the same underlying policy as part of the pool of policies? Quite possibly you could find a way to make that work.
As intermediaries we have an important role to play in matching suitability. If we succeed, we can broaden the investor base to support our protection buyer clients whether corporates, insurers and reinsurers. Investors should want to work with experienced securities broker-dealers who will take this responsibility seriously.
People are pretty aware of the risk on the investor side. I think poor understanding of the limits of modelling is an even greater risk for buyers (risk managers and ceded re managers). The general understanding of basis risk among buyers is inadequate. The retro buyer for a major Bermuda or European reinsurer is typically well positioned to properly evaluate basis risk. That is not otherwise true. I worry about index products with “no exclusions” that do not trigger when, for example, a small public company’s main manufacturing facility is destroyed.
While index products have some promise to expand the investor base and simplify modelling from the investor side, that simplification can often come at the risk of creating a larger problem when the buyer has purchased a cover they are not equipped to understand. We need to really develop that understanding more broadly if we want index products to grow on a sustainable basis.
How important is transparency in the ILS market and does this need to improve for the market to continue to expand?
Transparency is a larger issue for the industry. It is not just relevant to ILS. Higher quality and more timely data is necessary to help the industry deliver a more affordable and effective insurance product to policyholders. Big data and other insurance fin tech efforts could be an even bigger driver of this although ILS will benefit and could play a role too. We are just getting started.
What are your thoughts on the importance of liquidity in the secondary market, and can more be done to make ILS a more liquid asset class?
Accurate valuation is more important than actual liquidity for many investors. This is particularly the case for ILS funds backed by pensions or by pensions investing directly. Pensions and endowments do not really need the liquidity. That is part of why the proportion of ILS in underwritten widely distributed deals (the classic “cat bond” structure) has declined as the pensions have become more familiar with their ILS fund investments.
In contrast, UCITS funds and U.S. mutual funds need both accurate valuation and actual liquidity. As these types of funds grow in importance, more liquid structures add value by attracting more capacity.
A single investor investment in the preference shares of a Guernsey cell, a classic “collateralized re” structure will fail to meet the actual liquidity criteria. We see efforts to bridge the gap and some of those efforts are starting to gain traction where they make sense.
We use our Resilience Re platform as one of several tools in our toolkit to bridge the gap between classic cat bond and classic collateralized re structures where neither of the end points makes the most sense. It has been well received by investors and protection buyers where we have used it.
As efficiency of risk capital rises, do you think we could reach a point in time where ILS capital just cannot be beaten on price, or will scale and diversity always play into reinsurers’ hands?
ILS capital and reinsurers are both substitutes and complements in economic terms. People think of substitution and competition more often but it is also true that ILS capital can make reinsurers more efficient and effective at delivering client solutions. Many reinsurers have tried to blend ILS capital into their capital base, some more effectively than others. This allows the reinsurers to earn fees by sharing their considerable underwriting talent with investors.
Product innovation will continue to help investors put more money to work. Sometimes this will mean investors disintermediate reinsurers (or even insurers) rather than partnering with them. A reinsurer’s rated balance sheet is not always a more efficient source of diversification than some other technique such as buying reinsurance or using financial leverage. For example, ILS funds themselves certainly avail themselves of the retro market from time-to-time in part as a form of leverage.
What do you expect to see in the ILS space for the remainder of 2016 and also further into 2017, and beyond?
We expect continued steady growth in AUM. More and more family offices and HNWs are entering the space as ILS investors joining the pensions and endowments already leading the way. This emerging investor group could reverse the trend back to more liquid ILS.
There is also a continued push and pull to diversify perils. The “push” is that investors want more opportunities outside nat cat. The “pull” is that protection buyers outside of property cat are eager to gain the support of investors. As with 2016 so far, this trend will continue on a steady basis to the extent the underlying economics do not get in the way.
Our thanks to Bill Dubinsky for his time.
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