An increased understanding of the financial implications of catastrophe events and cash flow seasonality can assist further expansion of the ILS sector, at the same time as advancing the efficiency of the global insurance and reinsurance markets, according to Bill Dubinsky.
With the 2016 Atlantic Hurricane Season now officially underway, it’s a reminder of the strong seasonality of the international property catastrophe industry, with exposures peaking and dipping throughout the year across all regions of the globe.
In a recent report, Head of insurance-linked securities (ILS) at Willis Capital Markets & Advisory (WCMA), Bill Dubinsky, has discussed the financial implications various forms of seasonality have on the ILS space.
Although prominent, seasonality doesn’t just refer to the months of the year when U.S. hurricane activity peaks, or flooding events in other parts of the world increase, for example, but also certain fundamental operations of ILS funds and re/insurers themselves, explain Dubinsky.
“As a preliminary issue, re/insurance seasonality is complicated by the reserving and payout process. Neither cash flows nor accounting numbers move in lockstep with underlying events,” said Dubinsky.
Furthermore, firms don’t have perfect information regarding losses, and so early estimates can often fluctuate and prove substantially wrong in the end.
“Even assuming information was perfect, the reality is that a number of other factors come into play with ILS because the ILS market has some non-insurance influences on valuation,” said Dubinsky.
While for ILS funds, Dubinsky explains that inflows and outflows themselves involve a level of seasonality. The majority of ILS investment opportunities occur during the key reinsurance renewal dates, but in recent times transactions have been completed in the off months of a quarter and outside of renewals.
This is something Artemis discussed recently, as market experts highlighted the increasing number of ILS transactions taking place outside of renewals, owing to increased investor sophistication and market maturity.
With some even suggesting that following the reinsurance renewal cycle could actually be holding back the ILS sector.
However, currently, the majority of deals are transacted in line with the reinsurance renewal dates and, while perhaps a sign of market and investor maturity Dubinsky notes that inflows outside of traditional reinsurance renewals could have some implications.
“These cash flow mismatches may have a knock on impact on valuations in the absence of external players smoothing liquidity shortfalls and excesses. Loss activity can exacerbate these intra-cycles as capital gets locked up and unavailable for new investments,” said Dubinsky.
Furthermore, Dubinsky underlines potential seasonality impacts with regards to ILS secondary market trading; stressing that net asset value (NAV) calculations based “on a mark-to-model approach will solely reflect an often imperfect view of seasonal loss patterns (and will ignore seasonal volatility altogether as a separate influence on valuation).”
While these potential financial implications of seasonality on ILS funds are a reality, the key is for market participants and investors to grasp a greater understanding of the risks and factors that could influence the success of operations.
“We do see a handful of ILS investors who really try to understand these various forces and use them to their advantage. They may develop a slightly contrarian trading approach as they try to take advantage of some of these seasonal idiosyncrasies of which they believe their peers are blissfully unaware,” explained Dubinsky.
Another way investors mitigate the impacts of seasonality, and again, this also supports the increased sophistication of the marketplace and its participants, is by utilising a range of ILS solutions, such as cat bonds, collateralised reinsurance, sidecars, ILWs, and so on, “based on the seasonality and varying risk return patterns.”
While for brokers, adds Dubinsky, there’s evidence that some “take advantage of cheaper and more predictable execution by changing the timing of their re/insurance purchases.”
Ultimately, seasonality in various forms is inherent in the re/insurance and ILS space, with regards to operations and also the perils within the property catastrophe markets. In order to mitigate the financial impacts understanding and awareness is key.
“Indeed, more understanding of and attention to seasonality in all of its various forms can not only help grow and improve the ILS market but also make the broader re/insurance markets more effective and efficient,” concludes Dubinsky.