Redefining Insurance Risk: Matching Risk to Capital
One of the key challenges facing the insurance-linked securities (ILS) asset class today is exactly how to strengthen and reinforce the bridge between the insurance and capital markets. Having been developed initially in the 1990s as a means to transfer catastrophe risk via the well-known instrument of catastrophe bonds, today the demand for the capacity that can be offered by third-party capital has never been stronger.
How to achieve this mutually desirable outcome of efficiently matching risk to capital provided the theme for a panel discussion at Vesttoo’s recent Redefining ILS conference in New York.
Moderated by Steve Evans, owner and editor-in-chief of Artemis.bm and Reinsurance News, this session brought together industry experts to share their insights on the ILS market expanding to include new non-catastrophe lines of business. Participants were Amy Kessler, SVP and Head of International Reinsurance Strategic Initiatives at Prudential Financial; Michael Jameson, Managing Director and President of Global Programs at Howden Reinsurance Brokers Ltd; Jim Mann, Chief Risk Officer at Clear Blue Financial Holdings; Chris Collins, Managing Director at Corinthian Re; and William Cheney, Head of Insurance US from Vesttoo.
All participants agree that the ILS market is continuing to evolve from its pure natural catastrophe risk investment origins to something broader, more diverse, and ultimately more interesting to a wider range of investors. Right now, the ILS market remains dominated by property catastrophe risks, but increasingly we’re seeing stronger investor appetite for access to new types of risk.
Readers are invited to follow this link to the recording of the session, the key themes of which are summarised below.
- The opportunity and need to expand the ILS asset class has never been greater
All panel participants agreed that there is now a symmetrical and mutually reinforcing symmetry taking shape between the need for ILS to expand the capacity available to the insurance markets and the appetite from capital markets investors for diversifying assets. Michael Jameson stated that his team is interacting with investors, rather than traditional reinsurers, more now than ever before. However, in terms of getting more third-party capital providers on board, Jim Mann pointed out that the relative paucity of independent ratings is still a challenge with the sector still very reliant on AM Best.
The fact that more non-catastrophe lines of business are now being offered through familiar investment structures to investors has played a major role in making this possible. William Cheney voiced the view that non-cat ILS will reach around $90bn by 2027 (almost the size of the entire ILS market today), and all participants agreed that cyber and life/longevity deals in particular have been a major focus in terms of attracting heightened investor attention.
On the scale of the opportunity in longevity, Amy Kessler stated that longevity risk transfer transactions de-risking pension funds since 2007 have totalled over $750 billion. In 2022, in the UK, US, Canada and Netherlands alone over $80 billion in such transactions were recorded, with analysts forecasting the market to hit $1 trillion by 2025.
Here in particular then, third-party capital will be essential, and insurers and reinsurers taking pension risk will increasingly need advanced and innovative ILS solutions. Longevity can therefore, in Kessler’s words, be considered as the ‘next frontier’ for ILS.
- Diverse structures are essential
Another theme to emerge from the panel was the need for innovation to continue in terms of how deals are structured. William Cheney sees the further use of the full spectrum of options, swaps, and other innovative structures in addition to better known traditional reinsurance structures as all having a role to play. The future development of marketplaces will allow this innovation to progress faster, and Vesttoo aims to be at the forefront of this evolution of the industry.
Michael Jameson argues that further improvements to structuring will be the key to continuing to develop the asset class, more than what line of business is being securitised, and this is where many of the advances of the last few years have been. He emphasises that deal structure matters to all investors, and that an increasing amount are willing to take an agnostic approach to lines of business.
There was a consensus that investor education on these structures is paramount, both due to the unknown nature and complexity of the structured instruments involved. Chris Collins stated that situating ILS as a variation on well-known fixed-income products is usually a good starting point but was eager to stress that the development of fund or fund-like vehicles will move into the centre-ground for non-cat ILS over the next 5 years. This will give investors the ability to enter and exit positions, alleviating the bottlenecks that inevitably result from the one-to-one risk/capital matching pattern commonly used to date which will eventually act as a brake on growth.
Jim Mann agreed that intelligent portfolio construction was required to attract and keep new investors, and that this will allow the diversification of existing ILS portfolios into non-cat lines. Accordingly, even seasoned cat bond investors may well find there are reasons for them to branch out into non-cat lines.
- Efficiency and solving the redundancies in reinsurance as a whole
Finally, all panellists touched upon how ILS solutions can raise efficiency across the whole reinsurance value chain. Chris Collins argued that we must look at redundancies across the whole end-to-end process, and the benefits this can bring to all stakeholders. Most obviously, more efficiency in bringing capital to cedents means that rates paid by cedents can be lower, and this is extremely attractive to them in the current hard market. In general, he argued that there is a lot of “fat” to be trimmed, and the benefits of these efficiency gains can be quickly realised.
Chris Collins returned to a previous theme and noted that blending non-cat elements into cat-dominated ILS portfolios can dramatically decrease the volatility displayed by portfolios linked to fundamentally unpredictable natural events. For Michael Jameson, these efficiency gains from expanding ILS solutions to a wider range of risks will further reinforce the trend observed whereby a broader range of investors are today becoming interested in ILS in general, and non-cat ILS in particular.