Transparency required on trapped collateral: Darren Redhead, Kinesis

How transparent are ILS funds being when they factor in trapped collateral into their estimated returns? This was the question posed by Darren Redhead, chief executive of Lancashire-owned Kinesis Capital Management when he spoke to Artemis on the eve of the Rendez-Vous de Septembre in Monte Carlo.

There can be a difference in terms of how losses are reported to investors by reinsurer-owned ILS funds versus other ILS funds, he explained. “We are part of the Lancashire Group and reserve on a consistent basis with them. Others don’t and they may report different numbers. But how do investors want us to report losses to them?”

“We at Kinesis simulate a large number of loss examples showing our average returns,” he added. “In addition if a contract on the simulations has any level of loss we assume the full limit is trapped for a year, therefore simulating trapped funds in expected returns. We believe most other funds do not simulate trapped funds in expected returns, and therefore underestimated any drag on from that earnings.”

Redhead said investors were becoming more demanding in the aftermath of two major catastrophe loss years in 2017 and 2018. “The returns investors were promised when they reinvested in ILS vehicles after the 2017 and 2018 losses left some disappointed, but I think that’s changing and investors are being a bit more picky about what pricing they get going forward, and that has been a contributing factor to price increases.”

Pricing will continue on an upward trajectory as the industry moves towards 1 January 2020, said Redhead. “It will to my mind be similar to what we saw at mid-year, so year-on-year quite an increase from the previous year.”

“In the heavy rate-on-line and loss-affected sectors in retro, you are definitely seeing up to 10% to 20% average price increases year-on-year,” he said. “That’s being driven by reduced capacity and investors demanding better returns.”

However, the hardening in the retrocession market will not necessarily push up pricing in the underlying catastrophe reinsurance market, he thought.

“Where retro would drive direct cat pricing in the past, I would say that has changed. Whereas a long time ago nearly all entities chose to buy retro, that isn’t the case anymore.”

“So yes, there are small to medium-sized entities like Lloyd’s syndicates which have to buy retro, but there are other larger entities that don’t. So therefore you haven’t got the direct correlation between retro and direct cat that you once had.”

While a cycle still exists, Redhead thinks it is different to the reinsurance cycle of old. “What the ILS managers have done is reduce the barriers to entry to investors and money can come in much quicker now.”

Starting a new reinsurance company used to be the most common way to invest in the reinsurance arena post a major loss, but now, with the ILS managers, most investors access the market this way.
They decide what fund they want to invest in, what matches their risk appetite and which funds they like in terms of risk profile and how they manage themselves.”

The ILS sector has done a good job of reloading following losses arising from the 2017 HIM hurricanes and events in 2018, including Typhoon Jebi and the California wildfires. However, there have “been some bumps along the road in terms of loss creep”, said Redhead.

At the end of Q2 2018, cat bond losses from 2017 events reached an estimated $755m, but a year later this had grown to slightly more than $1 billion, according to Willis Re Securities.

“Not all losses have crept – the two main instances of creep being Jebi and Irma,” observed Redhead. “I think the losses each have their own unique dynamics as to why they crept, but I don’t subscribe to this notion that we’re going back to the late 80s/early 90s where all losses crept.”