ILS comes of age

As the largest insurance-linked securities (ILS) service provider in the world, Horseshoe Group is well placed to view trends, innovations and how the ILS market is developing in other ways.

The group administers some $31 billion of assets now, 95 percent of which is ILS-focused. It now has more than 85 people across offices in Bermuda, the Cayman Islands, London and North Carolina. It has expanded with and alongside the growth of ILS since it was formed in 2005.

That gives founder and chief executive Andre Perez a unique perspective on the ILS sector—and his predictions may surprise some. He believes that the ILS market is destined to continue to develop and play an increasingly important role in the way risk transfer works globally.

In part, he believes, fundamental differences between the expectations of investors from the capital markets and the reinsurance industry will drive more growth—as long as the industry continues to be able to find ways to package risks that are palatable to these investors.

“A traditional reinsurer will be targeting a return on equity in the mid-teens, whereas pension funds will be looking for much less. They love the fact that these risks have low correlation to other parts of their portfolio,” says Perez.

“Equally, the capital market is so big, it has the potential to put much more money to work on ILS if the deals were there. Conceivably, if some of the biggest pension funds and sovereign funds put a lot of money in this space, it would dwarf the entire reinsurance market capitalisation. And it is sticky money—in for the long term.

“The logical conclusion is that this market will continue to grow as it continues to innovate and more risks are packaged in such a way that the capital markets can participate.”

At the heart of ILS

The Horseshoe Group was formed in 2005 by a number of seasoned insurance and reinsurance professionals. It provides insurance services including the administration and management of companies, sidecars, transformers, catastrophe bonds and other risk-linked securities. It also provides actuarial services including valuation reviews and claims audit.

In 2016, it acquired IKONIC Fund Services, through which it then formed Horseshoe Fund Services (HFS), a Bermuda-based exempted company licensed as a fund administrator by the Bermuda Monetary Authority. HFS provides predominantly ILS fund administration and corporate services.

It also owns Horseshoe Re, a licensed Bermuda class 3 separate account reinsurer, which it uses to link the reinsurance market and investors who wish to participate directly in reinsurance risk. Horseshoe Re facilitates capital market participation in reinsurance transactions including industry loss warranties (ILWs), quota shares and excess of loss treaties by establishing fully collateralised separate accounts whose assets and liabilities are legally segregated from other Horseshoe Re segregated accounts.

Perez says that being a specialist allows the firm to focus on what it is good at, while also adding value to its clients. He says that the majority of ILS platforms launched in the last five years works with Horseshoe in some form and that, as well as its expertise in this area, its clients like the fact that all services are under one roof.

“We offer a turnkey solution for ILS platforms,” he explains.

He says the sector has been through an interesting period in the past 24 months, which has tested it in ways not seen before. The heavy losses from natural catastrophes in 2017 and 2018 would have represented a shock to some investors anyway, but the subsequent issues around loss creep, trapped capital and the lack of rate increases posed many questions for the sector.

Money is still flowing in, he says, but investors are being more discerning and are raising the bar in terms of standards and transparency in a way they haven’t before.

“There isn’t capital flooding in as it was a few years ago but it is still coming in, funds are still raising money and from new sources as well,” he says.

“Two things have changed. First, it has become apparent to investors that not all ILS managers are created equal, so investors are being far more selective in terms of where they put their money. And they want to know a lot more about exposures, pricing and valuations.

“Second, following one major ILS fund’s debacle, it is pretty clear the landscape has changed from a corporate governance perspective. They want to see more transparency and independent oversight of the ILS managers and the funds they invest in. They want to see things like independent directors and independent valuation review.

“This is a good trend for ILS as it ‘grows up’ as an asset class.”

He says that the market is also hunting for a solution, at least in part, to so-called trapped capital, where money is held in the aftermath of an event because losses are still being calculated or there is a dispute. Surprisingly large quantities of capital fell into this in the aftermath of the 2017/18 losses, which caused some investors to question the nature of their exposures and seek a solution.

Perez stresses that there is no easy answer to this, but things such as a bridge facility have been discussed in the past. The other option is for the collateral to be weighted according to its exposure to a risk.

“The problem with collateral is the first dollar of exposure being treated the same as the last,” he says.

“Of course, one of the solutions is for some firms to look at getting a rated balance sheet and therefore benefiting from leverage, but that course of action is reserved for the largest ILS funds. The quid pro quo is that you need to leave a large amount of risk capital in the company to keep that rating.”

Down the food chain

The real growth in ILS will now come through an expansion of the nature of the risks being passed into the capital markets, Perez says. He believes that investors are increasingly keen to move closer to the original risk. He gives examples of where managing general agents or insurers are being offered capacity or coverage from ILS fund managers leveraging money from the capital markets.

“That is happening more quickly than people think,” he says. “It is a different way of accessing cat exposure—ILS investors are getting much closer to the original risk. It is a form of disintermediation, but as investors are more educated they will be open to going further down the food chain.”

Linked to this is the development of new risks that could seek coverage via ILS structures. He notes that mortgage risk, financial guarantee, terrorism risk, operational risk and even lottery risk have all been covered by ILS type structures. He believes cyber risk will eventually follow and maybe even motor risk.

“These are all somehow short tail liabilities but they will open the market up,” he says.

“The holy grail remains casualty risk. Until someone finds a way of using ILS to transfer casualty risk, there will always be a limit in terms of how big this market can get.”

That said, he accepts there is still much growth ahead. As insurers in more countries embrace ILS as a risk transfer tool, this too increases the size of the pie and how diversified the available risks are. He notes that Australia and New Zealand, Latin America, the Caribbean and more countries across Europe are all now using ILS as an alternative to traditional capacity to a growing extent.

Added to this dynamic is the fact that London and Singapore have introduced regulatory regimes for ILS, which will encourage new risks and geographic regions to explore this form of risk transfer, Perez says.

“London can access risks Bermuda cannot and this could generate some interesting deals that we would not otherwise see,” he says. “London has the talent and the ability to originate risk.”

He feels that the only thing holding London back is the slow and arduous regulatory process and the high fees compared with Bermuda.

“Maybe they need to crawl before they walk,” he says. “Once the approval process becomes easier and cheaper, London should thrive. In contrast, Singapore has been much more aggressive, even offering funding deals issuance costs.

“We should keep in mind as well the Cayman Islands, which once was the largest ILS domicile, as they are attempting to regain some of that market share and have been quite commercial in their regulatory requirements.”

Bermuda, he notes, is pondering its own regulatory changes. The regulator is looking at creating a new class of insurer for collateralised reinsurance business models, which could also have an impact on the ILS market.

Perez is broadly supportive of the changes but adds: “I hope they don’t throw the baby out with the bathwater and make regulations too onerous.

“Some of the changes the Bermuda regulator is proposing are valid but it is a balancing act and one needs to keep in mind that you have very sophisticated parties doing business on these deals and all they want is transparent and efficient regulation.

“While Bermuda still has the lion’s share of the ILS market, it needs to be keenly aware that other jurisdictions are vying for the ILS business. I would warn against any drastic changes to the regulations as ILS entities can easily change domicile.”

For Horseshoe, he says, the focus is now on using technology to offer clients a better and more efficient service. He says it is almost inevitable that some of the technology available will have a big impact on ILS—blockchain for example could be used to detail every element of ILS deals going forward.

“We will remain specialist but we also want to ensure we remain at the heart of the market—in terms of size and innovation, as we are relentlessly focused on our clients’ success and how we can help them be successful,” he concludes.

Andre Perez is the chief executive officer of Horseshoe Group. He can be contacted at: andre@horseshoeglobal.com