Making an opportunity out of a crisis

The onset of the COVID-19 crisis, and in particular the market volatility that has accompanied it, has increased interest in insurance-linked securities (ILS), according to Henri Winand, chief executive officer of AkinovA.

AkinovA is an ILS trading platform that in May 2019 became the first company to be granted a licence to operate in the Bermuda Monetary Authority’s regulatory sandbox.

“Judging from the level of interest in ILS and electronic risk transfer we experience, I suspect the COVID-19 outbreak will have the same catalyst effect as happened post 2008,” says Winand.

He is quick to emphasise that COVID-19 is, first and foremost, a human tragedy. “We should not forget this,” he says. “It is seeing a number of people dying before their time, and others being penalised by loss of income, job or future, who need to repay the additional bill to fix the current dislocation at a time when there are already many bills to pay.”

However, in the short term ILS is seeing more inbound queries and interest as a result of the recent financial crisis, he says—just as occurred in 2008.

Winand acknowledges the significant differences that exist between the crisis of 2008 and that of today.

“The two financial crises are very different: 2008 started in the financial sector and went from Wall Street to Main Street, whereas this one is a simultaneous collapse of demand and supply on Main Street,” he says. The current crisis looks more like the impact of a world war, he notes—although he hopes it will be significantly shorter in duration.

What the crises of 2008 and 2020 have in common is that capital markets are demanding more asset classes that offer underlying cash flows that are quasi fixed income, he says. Investors are also looking for opportunities that offer decorrelation with generic real asset prices and equity prices. ILS, he points out, ticks all the boxes.

“Much like for any crisis or market dislocation, liquidity is king. So we see queries on ability to trade, re-trade and not be left with collateral trapped, for capital efficiency and velocity,” Winand explains.

He says it is natural to see an inflow of requests to trade simpler risk transfer products and instruments, which creates a virtuous circle, as the larger audience generates additional liquidity and so increases the attractiveness of the asset class.

“We’d expected to see people from the current re/insurance markets and ILS want to do more electronic risk transfer at a time when face-to-face business is not possible,” he continues. “That is the case, because of the need to go digital as face-to-face interactions are currently not encouraged.”

However, Winand says, that trend has been evident even without the influence of COVID-19. “This is a surprise to us,” he says. “For instance, a global insurer saw electronic trading of risk transfer as offering a better path to liquidity, which, of course, we agree with.

“They noted that with rapid dislocations ranging from wildfires and pandemics to cyber, there is an increased need to get more things done electronically, which enables them to re-adjust their risk portfolios more continuously.”

AkinovA is also seeing increased interest from brokers, he adds, with new members signing up for the service.

New sources

Increased interest in ILS is coming from a number of sources, but of particular note are pension funds. Pension funds are always on the lookout for interesting diversification opportunities, but, notes Winand, they may also be mindful of the fact that the mortality rates for COVID-19 look higher for the pension-age population.

“Since exchange-traded funds have been hammered by the COVID-19 crisis, we also see hedge funds managed by people—not only algorithms—coming forward,” Winand adds. “They seek a scalable asset class to invest into to establish new ways to hedge risks.”

Investors have had plenty of opportunities to assess how ILS behaves in different market conditions, from the market volatility of 2008, through years of higher than expected catastrophe losses, to the market volatility of March 2020.

Winand notes that ILS is exposed to correlations in weather patterns.

“If typhoons hit Asia in the same year as hurricanes hit Florida and New York, then the market suffers,” he says.

“If a pandemic cat bond experiences a true pandemic, as we see today, it correlates with capital markets.”

He urges investors to keep perspective. “Look at probabilities and look at this over a sensible timeframe. A pandemic is a shorter shock then a financial crisis, which is different from natural catastrophes.”

As ILS expands to more geographies, making the overall sector less exposed to US weather, with a little Asian risk thrown in for good measure, the asset class will become less correlated, explains Winand. But the industry will need better models and more indices, he says, coupled with better education about the asset class for investors.

Needed: more capacity

The increased interest in ILS will mean nothing, however, unless the asset class can grow in size substantially, Winand warns, and unless the collateral trapping issue is addressed. He points out that the market currently stands at around $100 to $130 billion overall, with around
$25 billion trapped. That, he says, is too small, compared with the trillions of dollars of dry powder, and the size of the capital markets generally.

“If the ILS universe of $100 to $130 billion is not growing, we’ll have too many dollars chasing too few assets,” Winand warns. That is going to have an impact on pricing and returns, he says, as reinsurers have seen over the last 25 years.

“We need to address this and transform ILS into a true, large asset class, for example by addressing capital velocity and collateral trading, increasing the use of electronic trading and gravitating towards simpler instruments,” he says.

“Using more parametric products will also help, as will efforts to educate buyers, sellers and brokers about the benefits of the industry.”

Ramping up issuance alone will not be enough. ILS needs to grow within a regulated framework, says Winand. “The insured risk, credit risks and contractual certainty all have to be organised correctly to truly unlock ILS growth,” he explains.

In the meantime, Winand predicts investors will continue to gravitate towards simpler, faster trades, particularly to securities that use parametric triggers, where AkinovA has executed a number of industry-first trades.

This is particularly true for businesses and asset managers looking to manage their pandemic risk over the next 18 months, he says. Risk managers are concerned about virus mutation and a potential secondary hit when restrictions are lifted on a rolling basis in the winter of 2020/2021, he notes.

This is likely to stimulate demand for pandemic trades over the next 18 to 24 months, he says, but also other lines, such as property/nat cat. Interest in property/nat cat may be accelerated with innovative parametric trades that incorporate ESG or climate resilience elements.

He also sees new property/nat cat products developed for wildfire risk.

“Tradable wildfire products are important, because those risks have not gone away,” he explains.

Winand warns that cyber perils could constitute the next global crisis, and says specialist forensics and cyber experts AkinovA is working with have been struck by headlines warning about increased ransomware attacks, spiking data consumption and advances in digital currencies. All these developments have important implications for cyber risk, he says.

While some of these effects may be temporary, the broader trend is of life being rapidly transferred to the digital world, from supermarket apps to law firms interacting with their clients remotely.

Many companies are struggling to keep up with the pace of this transfer of life to the digital world, says Winand.

“Companies are being thrown into the digital space without the layers of people training, process integrity and technology capabilities they need to smooth the transition,” he says.

“They are not ready but have no choice. That increases materially the risks of a cyber pandemic, but at the speed of light, as a more realistic scenario.”

It all spells growth for cyber insurance in coming years. And, of course, ILS will be there to increase capacity in the market, and offer new investment opportunities for investors.