Issues related to the potential for insurance-linked securities (ILS) collateral to be trapped, because of uncertainty over the COVID-19 pandemic and its potential losses for the insurance and reinsurance industry, have largely been postponed until after the January renewals.
While numerous insurance-linked securities (ILS) fund managers have already prudently reserved against every position they deemed potentially exposed to losses related to COVID-19 property business interruption, some had not and there are a number of catastrophe reinsurance programs where the threat of COVID losses still looms, we understand.
This had been assumed likely to come to a head around the negotiations for the January 2021 renewals, but we’re told that many opted to get the reinsurance and retrocession renewals completed and come back to this issue afterwards.
Two dynamics have been evident, our discussions with the market have shown.
Firstly, that some cedents have elected to let ILS funds and collateralized markets roll-over their capital into a renewal, rather than trying to trap any of it.
The motivation here is that by removing the risk of trapping and allowing for collateral to be rolled-over into a renewal deal, the ILS funds or managers were likely to have to offer better terms and pricing than may have been available in the open reinsurance market at the time.
We understand this option has been selected as preferred by some cedents and ILS funds, safely getting collateral deployed for another year.
For others, the key date looks set to be around the end of January, when ceding companies need to notify on whether they intend to put a hold on any of the reinsurance limit and collateral they had on-risk through 2020, if they believe their losses could rise to such a degree that it may be called on to support claims.
With the impact and potential for further losses from COVID-19 still very uncertain, we understand many ceding companies do want to retain collateral in case of court cases that suddenly throw more pandemic business interruption losses their way.
The issue here may be how you can hold onto collateral when you don’t have any filed claims notifications to evidence the need for it, which may lead to cases and attempts where collateral is requested to be retained based solely on IBNR estimates, which at that point in time have no evidence or grounding to them.
That could lead to the potential for disputes, as it’s almost certain ILS funds would only want to see their collateral held where valid claims are escalating and their is evidence of the potential for the collateral to be required for a claim on the reinsurance or retro layer it supports.
Which could make for some interesting discussions and the potential for legal action, should any cedents be particularly keen to retain collateral, but have little evidence to show that it is a necessity.
For those that allowed collateral to be rolled-over into renewal deals, there is still the possibility that ceding companies come asking for the collateral to be reinstated against the prior year agreement (it’s been seen before), so it’s to be hoped that agreements have been put in place to negate this risk.
While the issues related to possible trapped ILS capital due to COVID-19 seem to have been largely postponed, allowing for a more orderly renewal. They certainly haven’t gone away.
As one broker put it to us, “If I was a cedent with policies still on-risk for COVID BI rulings that go the wrong way, there’s no way I’d be giving any collateral back.”
Of course, this issue could actually run on and it’s encouraging that cedents and ILS markets have in many cases found ways to keep moving forwards, despite the pandemic threat still hanging over them.
Those who reserved for all their potential COVID BI exposure early on will be pleased at the lack of legacy now in their fund strategies, while those that didn’t may face another uncertain few weeks and perhaps even months, as the potential trapped ILS collateral issues roll-forwards into 2021.
Whatever the outcome though, it seems likely the trapped collateral issue is not going to be as significant as had previously been thought, for the ILS market as a whole. Although for certain strategies it could be more impactful than others.