Executive Director,  Sherman Taylor serves on the board of a number of ILS vehicles registered in Bermuda. Below, he provides a unique view of the asset class from a boardroom perspective.*

Insurance-linked securities (ILS) are a mechanism to transfer underwriting risks from (re)insurance companies to the capital markets, usually hedge funds, pension funds and other sophisticated, institutional investors. The nature of these transformer-type structures means that specialised knowledge of both the insurance and capital markets is required.

In Bermuda, Special Purpose Insurers (SPI) are typically used as vehicles for ILS deals. These SPIs must adhere to a robust regulatory environment that includes a code of conduct with a requirement for a board of directors that is fit and proper and composed of directors with adequate subject matter expertise. These boards often include directors from both the insurance manager and the corporate service provider. Bermuda's deep insurance and capital market talent pools allow for easy fulfilment of this requirement.

There is a clear shift away from commoditisation in the ILS sector, and diversity and innovation are increasingly evident. Naturally, this increases the level of board expertise required. For example, in the past five years we have seen a broadening of the general structure of ILS deals, the incorporation of new technology, and a move towards adopting ESG into ILS platforms. Additionally, ILS now provides coverage of less conventional risks such as credit default risks, operational risks, terrorism risks, and even pandemic risks. The geographical areas of cover have also expanded, with ILS deals now covering regions of Latin America, Asia and Africa. Taken together, these trends mean that boards must have similarly broad commercial experience and a thorough understanding of the ILS market.

Board expertise is particularly important when commercial challenges arise. Covid-19 has certainly demonstrated this and while direct losses from Covid-19-related pandemic risks were mostly limited to the World Bank's pandemic cat bond, anxiety remained high about losses attaching to ILS; some ILS funds even made provisions for potential losses. This highlights the need for boards to have the necessary fiduciary expertise required in order to effectively guide SPIs through events sitting outside the normal course of business.

Sound corporate governance at the SPI level plays a key role in the future of the ILS sector. There are significant growth opportunities for the asset class as investors seek to diversify their portfolios to reduce exposure to equity market shocks (such as the one precipitated by Covid-19 in 2020). However, the ILS sector must retain the confidence of the capital markets to continue to realise these opportunities, and good governance is fundamental to this. Success can be seen in the form of new ILS funds being established on the back of excellent performances from exiting ILS funds.

Specialist knowledge at board level is also required when conducting both the larger 144A ILS deals and the smaller “collateralised re” deals. The latter tend to be more innovative and customised, and many have unique structural features because they are more directly negotiated between participants.

Most ILS deals are listed on the Bermuda Stock Exchange and there are continuing obligations that issuers must comply with. Here, the board must be aware of the additional responsibilities placed on the SPI by virtue of its securities being publicly listed.

The board must also have a strong understanding of the legal and regulatory environment its structure is situated in, ensuring the vehicle keeps up with regulations, operates transparently, and avails itself of the most beneficial rules available.  For example, in October 2019, Bermuda revamped its regulations for SPIs, providing, among other things, a very useful 15-day grace period for collateral to be in place in ILS deals.

Good corporate governance has played an important role in the success of the ILS sector, and it is no surprise that ILS is becoming increasingly recognised as a traditional asset class.

Originally Published by Artemis' Q1 2021 Catastrophe bond & insurance-linked securities (ILS) market report

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