Fiona Le Poidevin of Guernsey Finance examines the attractiveness of the Insurance Linked Securities asset class and what role domiciles can play.
Investors and managers continue to be drawn to the non-correlated nature of insurance linked securities (ILS) investments.
It's not only because ILS products are non-correlated with the general financial markets that they are liked, but the fact that they are also providing good returns at a time when a low interest rate environment remains. Although specialist catastrophe funds remain the largest investor in ILS, mutual funds including pension funds and institutional investors have increased their participation in the asset class significantly.
Aside from investors, insurers like ILS because it enables them to purchase additional protection for low frequency, high severity losses, including natural and non-natural perils, operating in the traditional insurance market, typically in the form of catastrophe (CAT) bonds, collateralised reinsurance or industry loss warrants.
Indeed, the popularity of ILS is borne out in figures from Aon Benfield Securities to the end of last year, which shows that 2013 was a ground-breaking year for the ILS market with a full-year issuance total of $7.5 billion. The strong issuance seen in 2013, the second strongest single year on record after 2007, helped the total amount of catastrophe bond limit outstanding jump to $20.3 billion, according to Aon Benfield Securities, the highest level in the market's history.
Offshore jurisdictions such as Guernsey, Bermuda and Cayman are at the heart of the growth in the ILS market, while onshore locations including Dublin, Malta and more recently Gibraltar are increasingly looking to the potential of the asset class. Taking Guernsey as an example, the 'twin-attractiveness' of ILS suits it perfectly as the Island has a long track record and existing expertise in both the insurance and investment fund sectors which can be combined and optimised in its ILS offering.
Guernsey, which is ranked as the number one captive insurance domicile in Europe and the fourth largest globally, saw 89 new international insurers being licensed during 2013, a large proportion of which were vehicles relating specifically to ILS and their use of Protected Cell Companies (PCCs). Guernsey insurance managers Robus and Aon Captive and Insurance Managers (Guernsey) were responsible for approximately 40 of these new additions between them.
In 2013 Robus' Protected Cell Company (PCC), Hexagon PCC Group, established 22 ILS structures under the Hexagon PCC Group umbrella. These structures are being used to conclude fully collateralised reinsurance contracts (sometimes known as private trades) in the non-life space. These see each cell enter into an excess of loss/aggregate/quota share reinsurance policy for various covers such as property (natural and non-natural perils), marine, energy, crop, premium reinstatement or prize indemnity. The cell is then fully funded by the investing ILS fund up to the amount of its maximum obligation under the reinsurance contract.
Meanwhile, Aon Captive and Insurance Managers (Guernsey) have been involved in more than 80 ILS transactions since 2006, with annual transactions increasing year on year. One of those is Solidum Re Eiger IC Limited, an insurance vehicle which listed bonds with a value of $52,500,000 on the Channel Islands Securities Exchange (CISE). The transaction was a reinsurance placement accepted by an incorporated cell from a US cedent. The transaction utilised a dual listing on the CISE and the Vienna Stock Exchange. It was also the first ever private catastrophe bond listed on any exchange worldwide.
Industry feedback also suggests that a number of collateralised ILS transactions were completed in 2013 which saw International Swaps and Derivatives Association (ISDA) contracts being used as an alternative to a reinsurance contract, demonstrating the breadth of the collateralised reinsurance and ILS business currently being undertaken.
While Bermuda and Cayman arguably remain the most active in the ILS space at present, particularly in the volume of platforms such as CAT bonds issued to retail investors, Guernsey has developed a niche in more bespoke products that are created in conjunction with the investors – both institutional and professional – as well as the managers. An example of this is a structure judged to be one of the Islamic finance deals of the year for 2013 and the top deal in Europe by Islamic Finance News. The structure, the Salam III, Sukuk Wakalah Programme, was devised by Bedell Cristin's legal team in Guernsey, on behalf of the European insurance group FWU AG. The deal, which was praised for its innovation, was $100 million in size and the first tranche of $20 million closed in October 2013. Bedell Cristin was counsel to the issue and the issuer and worked alongside the European Islamic Investment Bank, Rasmala Group and legal firm Morgan, Lewis and Bockius.
The deal also demonstrated Guernsey's high-standing in the international funds sector due to the experience which has accumulated over many years in dealing with a broad range of asset classes such as private equity, venture capital, funds of hedge funds, infrastructure, property and now ILS as a standalone asset class. Guernsey provides access to capital markets, most notably the London Stock Exchange (LSE) and other international exchanges including Hong Kong, Toronto, Ireland and Euronext among others, as well as the domestic CISE.
For example, the Guernsey domiciled DCG Iris Fund listed on the Main Market of the LSE in June 2012 after Dexion Capital raised more than £60 million for the vehicle – a closed-ended feeder fund into the Low Volatility Plus Fund managed by Credit Suisse Asset Management's ILS team. DCG Iris announced in January of this year that it had achieved a total return of 2.2% in the six months to 30 November 2013, helped by low catastrophe losses. The company said it had also boosted returns by shifting away from catastrophe bonds into higher yielding private collateralised reinsurance deals. Guernsey actually has more entities listed on the LSE markets than any other jurisdiction globally (excluding the UK).
LSE data to the end of December 2013 shows that there were 115 Guernsey-incorporated entities listed across the Main Market, the Alternative Investment Market (AIM) and the Specialist Fund Market (SFM). Guernsey added 17 new entities during 2013, which again was more than any other jurisdiction except the UK itself. Sufficient liquidity is a major challenge for many insurance related funds, but Guernsey's experience in successfully listing vehicles on the LSE and other markets is a key ingredient of its offering, as is the Island's experience of dual listings. Dual listings bring with them the potential liquidity offered by a secondary market, such as the local CISE, which is a major benefit for an ILS investment strategy.
Many onshore domiciles will point towards the anticipated introduction of Solvency II in 2016 as a catalyst to greater opportunities for ILS offerings within the European Union. Guernsey and other offshore domiciles are content that current 'fronting' arrangements will continue – as had always been the case for these jurisdictions previously. Guernsey, which is not part of the EU and is not obliged to adopt the requirements of EU directives, announced as far back as 2011 that it would not seek equivalence under Solvency II, thus providing certainty to its international client base going forward.
Under the current proposals, Solvency II is set to impose a blanket set of capital requirements and therefore equivalence would burden Guernsey and other offshore insurers with unnecessary additional costs and render currently effective business plans uneconomic. Guernsey's propositions to comply with the standards laid down by the International Association of Insurance Supervisors (IAIS) and as part of this, it is developing its own solvency regime. This is actually attractive for insurance vehicles currently based within EU domiciles, especially where they are writing business outside Europe and may become increasingly so if the uncertainty regarding Solvency II continues and if the implications for insurance vehicles appear particularly onerous. Guernsey's decision not to seek equivalence with Solvency II means that it offers ILS structures the certainty of a regime which is proportional, risk-based and free from any potential restrictions set to be imposed by Solvency II.
Offshore domiciles are also in an advantageous position for ILS when it comes to EU legislation such as the Alternative Investment Fund Manager's Directive (AIFMD). For example, with Guernsey not being in the EU, it is not required to implement AIFMD and is considered a 'third country' for the purposes of the Directive. This ability to either stay out or 'opt in' to the rules could be of critical importance, particularly for the many ILS funds that are targeted at only non-EU investors.
With that in mind, Guernsey has introduced a dual regulatory regime for investment funds, which sees Guernsey's existing long-standing flexible regulatory regime remain in place for those investors and managers not requiring an AIFMD compliant fund, including those that avail of EU National Private Placement (NPP) regimes and those who market to non-EU investors; and there is a new opt-in regime which offers full AIFMD equivalence – for those for whom it is necessary or otherwise desirable to have an AIFMD compliant fund vehicle to take to market.
ILS managers and funds with no connection to the EU should continue to use Guernsey's existing flexible regulatory regime which is completely free from the requirements of AIFMD and as such, will have significant operational and cost benefits. As a third country, Guernsey-based managers and funds who want to access Europe continue to use NPP regimes, which are expected to remain until 2018. The NPP route will likely be favoured by many given that the requirements to satisfy AIFMD will be significantly over and beyond what is required under NPP.
Guernsey has an existing base of clients for whom Europe is at least a very important market and the opt-in equivalent regime which has been in place since 2 January 2014 will be appropriate and appealing to such funds. It is for this reason Guernsey enacted the equivalent rules ahead of when they were actually required to do so. Full passporting for non-EU AIFMs is expected from July 2015 and Guernsey managers will be ideally placed to market on a pan-European basis with a single authorisation, as passporting is currently envisaged to operate.
Guernsey's funds regime is just one of a number of outstanding factors that means the Island provides a unique proposition as an offshore hub for ILS business. Recent statistics suggest this is now being recognised by many in the market itself and as the demand for ILS funds continues, as is anticipated if pricing remains attractive, then it is likely that Guernsey's reputation for its special-purpose insurers, cat bonds and transformer structures, will become a key ingredient in its success moving forward.
An original version of this article was published in Clear Path Analysis' Insurance-Linked Securities for Institutional Investors report, May 2014.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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