Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Trapped collateral concerns overblown at 1/1, but COVID discussions continue


At the recent January 1st 2021 reinsurance renewals, the expectations for significant impairment to some insurance-linked securities (ILS) strategies because of trapped collateral due to exposure to the COVID-19 pandemic proved overblown.

trapped-capital-imageAs the end of 2020 approached, some were forecasting that a significant amount of insurance-linked securities (ILS) capital could become trapped over potential business interruption exposure in property catastrophe reinsurance or retrocession programs and that this could dent the ILS market’s capabilities at the important renewal season.

While many of these discussions were postponed until after the renewals, some were expected to intensify.

In the end, this proved overblown according to leading reinsurer and ILS capital manager RenaissanceRe, saying that “Concerns over trapped collateral, particularly associated with COVID-19 business interruption claims, were less pronounced than expected.”

In fact, we understand that more ILS fund capital was trapped due to aggregated catastrophe claims than due to potential COVID-19 pandemic exposure.

One reason for this was that ceding companies took a realistic approach to the end of the year, preferring to ensure they could secure their necessary reinsurance and retrocession from ILS partners at the renewals, so delaying discussions on trapping.

With collateralised reinsurance and retrocession, the key date is often seen as the end of January anyway, the point at which a demand to hold collateral must typically be delivered on behalf of the cedent and so ILS funds tend to have a clearer picture of potential trapped collateral that will be stuck in side pockets.

However, we’re told that while discussions over COVID related trapping of ILS capital did intensify around that period and into February, realism continued to hold sway and in a number of cases collateral releases were signed as the chances of a cedent actually experiencing sufficient claims to hold onto the capital were seen as minimal.

We understand there has been some legal activity over all of this, particularly in the retrocession space, where collateralised writers have been asked to allow collateral to be trapped, even when there has been little to no actual loss reported.

As a result, trapping claims have been made based on an incurred but not reported (IBNR) claims basis, although we’re told there are a handful of disputes in progress, as ILS capital providers claim there is little actual evidence of the claims being incurred in the first place, it seems.

Uncertainty persists though and some ILS capital has already been trapped because of the pandemic, with side pockets having been set up as early as March or April 2020, in some cases.

But some of these early side pockets have now been released, we’re told, as it became clear at the end of the year that claims against the trapped ILS collateral held were unlikely to manifest.

Discussions are ongoing in some quarters and it’s still uncertain whether more collateral could be held over the coming weeks.

In addition, new reserves have been set by some ILS fund managers in the final months of 2020, as it became clear some European property catastrophe reinsurance programs were likely to seek recoveries from their capacity providers.

But overall, it seems the fears of a significant ILS capital trapping event over COVID at the end of 2020 were overblown and now the discussions ongoing are largely on realistic terms, with just a few perhaps set for more meaningful disputes to drag on.

As an aside, collateral release related to prior year events also ramped up towards the end of 2020, which helped to replenish some ILS funds a little and also played into some of these negotiations we’re told.

It seems the ILS market has dealt with the trapped collateral issue well so far and either paid its claims when due, or recovered capital when it turns out they are not due.

This example bodes well for future loss events that result in trapped ILS capital, as it’s clear the market has dealt with this responsibly, with respect for the cedent and the capital provider, in the vast majority of cases.

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