ILS practitioners from Guernsey spoke at a Guernsey Finance London event about prospects for the sector and the island's role in the market. In the first of two articles, we cover some of the issues raised.
How do you see the state of the market today?
Justin Wallen, Head of ILS, Artex Guernsey: The market recently has been difficult for ILS clients compared to 2016 and prior. Losses and collateral trapping from events in 2017, 2018 and, more recently, the 2019 typhoons in Japan, is making the deployment of collateral for new transactions more difficult. Also there is some disparity between types of contracts and losses suffered, in, for example, excess of loss reinsurance versus aggregate contracts versus quota share.
Overall that is not a great position for transaction volumes. Trapping of collateral led to specific issues around the mechanism of release and limited/delayed reporting from certain cedants, partly because with all the 2017 buffer factors now extinguished, there is more caution in the market when it comes to releasing the remaining 2017 and 2018 trapped collateral.
2020 might see some new transactions, where we saw next to no new business in the collateralised re space in 2019. We might see some more transactions coming through in 2020, with retro likely to be a particularly tough environment.
Paul Sykes, Managing Director, Aon Guernsey: The market is dislocated in a way that we haven't seen happen since 2006 when the traditional reinsurance industry deserted the retro market post-Katrina, and ILS capital came into the market in a bigger way. ILS capital is said to have accounted for up to two-thirds of the retrocession market, so while that capital is "trapped", historical levels of retro cover are unavailable, and the price for the cover that is available is inflating. However the price for the primary insurance and treaty reinsurance coverage has not corrected to the same extent yet, which is why the situation is being described as dislocated.
There is more capital waiting to come into the market, but investors are watching to see what happens on rates and price increases, which ultimately translate to investment returns. After the 2017 losses many investors 'reloaded' their funds, but since then we have had the most intense natural catastrophe activity over a consecutive three-year period since 1959. It is no surprise that this experience has tested investors' sense of humour.
And while we have a good track record of bringing capital towards risk in the ILS market, the spectre of trapped collateral, which can't be redeployed to earn returns for investors, raises questions over the efficiency of the distribution channel. I expect the renewal season to run long and late this year.
Are you seeing concerns about climate change impacting the ILS market?
Justin Wallen: Investors have started to voice concerns that the models haven't necessarily accurately priced the issues around climate change, and this is a challenge for ILS Funds to provide comfort to investors around the impacts of climate change on their investment returns.
Paul Sykes: Around the Japanese typhoons, there are certainly concerns. Reports of loss creep around typhoon Jebi originally, followed by Faxai loss mis-estimation, probably tested investor confidence a little bit with the quality of data and analytics. It was notable how little publicly available information regarding loss forecasts there was immediately after typhoon Hagibis, and when estimates began to be published they quoted very wide ranges of potential loss quantum.
Guernsey reinforced its position over EU-domiciled insurers purchasing reinsurance under Solvency II regulations earlier this year. What does that mean to the island practically?
Paul Sykes: The market access that Guernsey industry has is pretty much unfettered by virtue of the quality of the collateral supporting collateralised reinsurance transactions or the positive effects of a rating. That's not necessarily what you will hear in Europe, but by the letter of the regulations, we're able to carry on doing what we're doing. Our aim and offering to clients doing their business from Guernsey is that we can reduce expense ratios for clients.
We hear there is a trend of clients who were traditionally using Bermuda for ILS, now hedging their structuring in Bermuda and Guernsey?
Justin Wallen: My original sales pitch back in 2012 when I started out with a 100% focus on ILS was to offer a second service provider in second domicile rather than having all eggs in one basket, with the added convenience of Guernsey's time zone and proximately to the London market and ILS funds managed in London and Zurich. That's still a valid strategy for our clients.
Paul Sykes: We have clients expanding both ways. Guernsey tends to service investors based in London and Zurich, while we have set up operations in Bermuda for Guernsey clients to service US investors. Besides investor preference time zone is also a factor in the jurisdiction selection process.
Guernsey formalised its rollover provisions at the end of 2018. Has this had an impact on the local market?
Justin Wallen: The confirmation of rollover has been a positive development, with the 30-day collateral grace period really just reflecting how the market was working in practice anyway. Then from perspective of rollover it is very helpful to enable us to have 30-day grace period, given that again in practice there is only ever one pot of collateral to be rolled into the following year in the event that there are no losses on the expiring year.
Emma Bailey: Our approach is predicated on the concept of
regulatory forbearance. Rollover is a classic example of that, and
it seems to be working at the moment.
What is the Guernsey approach to clawback?
Justin Wallen: We can facilitate clawback in Guernsey through individual contracts where the specifics are clearly set out. There have always been elements of clawback in certain contracts performed in Guernsey over the years, with the manager and director of the Protected Cell Company given sufficient flexibility by the regulator to ensure they have comfort around their ability to access more funding, should clawback be necessary.
How do you see the future for collateralised and rated reinsurance options?
Paul Sykes: There are protagonists on both sides of the debate between collateralised reinsurance versus rated reinsurance. Some are prophesying that collateralised re will reach a sell-by date but I don't see that being the case. We are seeing a number of investment managers setting up rated insurance companies, so we've been part of that trend, but it's pretty capital-intensive and long-term, and therefore unsuitable for many investors. I don't see that's going to change any time soon.
For more information about Guernsey's finance industry please visit www.weareguernsey.com.
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