The implementation of insurance-linked securities (ILS) regulation in the United Kingdom could result in increased opportunity for the capital markets to directly access insurance and reinsurance risk, resulting in increased pressure on pricing and rates, according to analysts.
Yesterday’s unveiling of a set of draft ILS regulations and associated tax rules by the UK government during its Autumn budget statement has been well-received by the market.
London is seeking to gain a share of the ILS market, enabling transactions to be hosted in the UK with no penalties and a level playing field for tax on investments in the ILS structures.
But the end result may be a continuation of the trends which have of late been detrimental to traditional insurance and reinsurance market players, the entry of more efficient ILS capacity from capital markets investors and the subsequent pressure on reinsurance rates.
Peel Hunt’s analysts explained; “The Government has confirmed it will put final regulations in place before Parliament in spring 2017 to facilitate the development of an ILS market in the UK (eg Catastrophe Bonds, Collateralized reinsurance, etc). The Treasury states this will help strengthen London’s reinsurance hub (we believe within the Lloyd’s market in particular).”
Strengthening of the London insurance and reinsurance hub is vital at this time when the UK faces threats from international competitors, the growing ILS market, insurtech upstarts, as well as the difficulties posed by Brexit uncertainty.
It’s a tough time in London for some and bolstering the reinsurance market is seen as a positive win right now. However is London and the UK ready for what it might mean if they let ILS capacity and the capital markets wholesale into the London reinsurance market?
“An easing of tax regulation and the facilitation of SPVs will boost London in the area of alternative (re)insurance capital markets,” Peel Hunt’s analysts continued.
Before warning that; “Alternative capital accounts for c20% of reinsurance risk exposures in H1 2016 and the increase in alternative capital has been one of the main reasons behind the softening of reinsurance rates. Hence, it is likely that reinsurance rates, in particular, will remain soft should a liberalisation of ILS in the UK attract more capital.”
Of course this is entirely true and likely what will happen, it is a natural progression of the evolution of insurance risk transfer.
Now the capital markets have found a home in ILS, one which the majority agree is not going away and will only grow in importance, by welcoming more of this capital into the UK and London the end result can only be further growth for ILS and therefore more pressure to prevent reinsurance rates from rising as they used to.
But this is a good thing and actually the UK, London and of course the Lloyd’s market, has to get used to this new paradigm of risk being matched to the most efficient and optimal capital source and work out how to profit from it.
Some players will have to get used to the fact that their own capital and balance-sheet leveraged capacity may not be as efficient as direct capital sourced from investors and deployed through capital market structures.
Is the UK and the London insurance and reinsurance market really ready for what could happen once it unleashes the ILS genie from its bottle and welcomes the capital markets into its midst?
One can only hope so, as anything else is simply denying the fact that ILS and the capital markets will play a major role in the London market’s future.
It’s how this efficient capital is leveraged to bolster and strengthen London that is vital. To allow the underwriting and origination expertise in the city to focus on becoming the analyst and pricing experts of risk, the product creators and the advisors to those seeking risk transfer, while capital in all its forms flows freely to be matched with it.
It’s time for companies to identify where they bring value to the much discussed value-chain, how they can extract profitability from wielding that valuable intellectual capital and to realise that there may be capacity providers out there now who can do that job more efficiently than they.
Change is coming (as it has been for ever, this market evolves all the time) and London may have just unleashed a new wave of it.