Advancing efficiencies in a changing world

17-09-2020

Advancing efficiencies in a changing world

Anna Pereira, ILS Bermuda

Despite high systemic market pressures, investors continue to be attracted by the features that have established ILS as a highly desirable asset class: its liquidity and low correlation to the broader financial markets, as Anna Pereira, head of overseas markets and promotion at ILS Bermuda, and director at MANA Consulting, explains.

The latest figures for the second quarter of this year show the continued growth of the insurance-linked securities (ILS) market. Given the competencies and market-leading position of Bermuda, we continue to see new listings on the Bermuda Stock Exchange (BSX).

With the outstanding catastrophe bond and ILS market size at $41.5 billion at the end of the Q2 2020, the BSX is by far the world’s leading exchange for ILS, including listings from other jurisdictions, with 470 listed issuers and $38.1 billion in market capital outstanding, representing over 90 percent of market share of global ILS.

There is also increasing interest from jurisdictions around the world to use alternative reinsurance solutions such as ILS to help close the protection gap and provide recovery and resilience to communities. While there is also increased competition from other jurisdictions, this competition keeps us nimble and ahead of the curve.

“Now is a prime time for companies to take a thoughtful step back and reassess how they view and manage risk within their organisations.” Anna Pereira, ILS Bermuda

Bermuda is uniquely positioned with a long history as a centre of excellence for innovation in risk transfer. Market disruptors create opportunity and new partnerships, and this is an excellent time for Bermuda to do what we do best: act as the incubator for developing and implementing new and emerging strategies.

Bermuda’s regulatory framework has created opportunities to develop and leverage the progressive commercial and regulatory approach already adopted in respect of digital assets and fintech. In the future, we expect to see ILS leveraging digital issuance to grow the investor market and increase liquidity.

Bermuda will be in a position to lead in this space given our existing Digital Asset Business Act 2018 (DABA) legislation and regulatory framework.

We are also seeing insurers, reinsurers and ILS funds accelerate plans for growth in order to take advantage of the hardening market. Following property rate improvements throughout 2019, rating agencies are reporting expectations of continued rate hardening into 2021 with non-life commercial insurance providers already reporting double-digit price increases for a variety of lines of business across all major global regions after a long period of mostly flat rates.

As Fitch Ratings noted in May: “Prices have been rising for nine consecutive quarters as peak losses and accelerating claims inflation have forced the industry to respond.” 

After the pandemic

It’s expected that commercial insurers and reinsurers will be hit by pandemic-related losses while also being confronted with political pressure to pay for business interruption claims, whether or not the relevant underlying policies cover pandemic risk.

Some carriers have increased prices significantly in loss-affected lines and some have reportedly withdrawn completely from certain lines or geographies. These actions have had a positive impact on the overall firming of rates but may prove problematic for risk managers.

An AM Best market segment report on Florida property insurers notes: “In response to Florida’s challenging operating environment, reinsurers are increasing rates by an expected average of 25 percent or higher, and individual company rates vary considerably based on loss experience, risk appetite and financial condition.

“Even before the pandemic, Florida insurers faced an uphill battle with the hardening reinsurance market. Reinsurers have incurred considerable assumed losses in the past several years, owing to hurricane activity and rising claims severity brought on by social inflation.” 

This is further exacerbated by volatility in financial markets and the economic downturn: carriers are no longer making the stable investment income they once enjoyed. During the insurance industry’s soft market when premium rates were extremely low, insurance carriers relied on their investment return to shore up overall profitability.

With that option greatly reduced, the ability of insurers and reinsurers to produce adequate underwriting returns will be central for the foreseeable future.

Chair of ILS Bermuda Kathleen Faries says: “This is our moment as an industry to maintain underwriting discipline and achieve a more sustainable pricing environment given what will be a very challenging investment return environment for some time.

“We should leverage technology to better inform ourselves and stakeholders on what an adequate return is for the actual risk we are assuming and push the modelling firms to reflect changing climate dynamics and for the industry to work together to advance on risk transfer efficiencies and reducing overall costs.

“End investors—the ultimate risk takers—can also play a pivotal role in moving the industry forward on maintaining underwriting discipline and delivering on transparency. We have seen investors asking more questions about reserving practices, loss adjustment expenses, and return on risk; providing more transparency and clarity to investors about the risk they are assuming will ultimately help us to grow the ILS market.” 

Drivers

While there are several issues driving the hardening market, one of them has been persistent high loss ratios since 2013, primarily caused by an increase in the frequency of severe property losses. Insured losses in the aggregate have steadily been rising without corresponding rate increases until recently.

Trapped collateral and the ongoing development of catastrophe losses from 2017 and 2018 hurricanes and wildfires also create a drag on investment returns from collateral held by cedants and has become a more important consideration in the risk pricing of collateralised reinsurance contracts.

Cyber breaches, climate change, pandemic, trade and political risks are at the top of mind for most business leaders. After concluding that COVID-19 is an unprecedented event for the industry, now is a prime time for companies to take a thoughtful step back and reassess how they view and manage risk within their organisations.

Jo Stanton, head of finance at Tangency Capital and vice-chair of ILS Bermuda, said: “Climate change is an opportunity for the market to strengthen the analysis of risk and make sure that it is being paid for the risk taken, including the uncertainty about the effects of climate change.

“Climate change is an opportunity for the market to strengthen the analysis of risk and make sure that it is being paid for the risk taken.” Jo Stanton, ILS Bermuda

“The extent to which this will lead to more severe tropical cyclones, or wildfires for example. Awareness of climate change and the potential for more severe events increases demand for coverage and gives us the opportunity to ensure that adequate cover is available at the appropriate price.”

The ability to move capital into the market quickly to take advantage of higher returns usually offsets price increases. However, this supply/demand dynamic doesn’t appear to be happening to the same extent in the current market and new capital may wait on the sidelines to see some stabilisation.

Due to the unfolding fallout in the global economy and the response to the pandemic, supply chain disruption and decreased non-ILS liquidity, some investors with capital to deploy are going to look for relatively safe havens.

Over the years there has been a shift in the way re/insurers approach new technologies. Manual processes are being replaced with automated and paperless systems. Enabling and accelerating the move to digital has become a strategic priority. With COVID-19 acting as a catalyst for more remote working, this is expected to continue.

Tech-focused trends in the industry have led to simplifying more complex processes as customers demand speed and ease. Implementing and improving machine learning and artificial intelligence techniques to optimise processes and gain a deeper understanding of risk will likely accelerate in the coming years.

Those who had the foresight to invest early in the automation of key value chain operations such as underwriting and claims handling will see improved profits over time. More impactful efficiencies and profit gains for the industry will be reached only when there is true collaboration from the industry as a whole.

An expectation for above-average storm activity predicted for 2020 could lead to more accumulated insured losses, and the COVID-19 crisis has the potential to amplify damages. Compounding the situation is the need for insurers to purchase prudent reinsurance catastrophe protection despite the elevated costs.

We are seeing brokers predict that the COVID-19 pandemic will be a catalyst for all-round hardening of the reinsurance market, almost irrespective of line of business. Traditional retrocession capacity is at a premium in terms of capacity available for renewal business, and the retrocession market is expected to firm up considerably.

This is an area of the reinsurance market where capacity has been severely dented by repeat catastrophe loss years and we should expect to see the majority of retrocession programmes that renew at January 1 impacted by higher rates due to pressure on both sides on the balance sheet.

The catastrophe risk market, where Bermuda plays a significant role, may see increased demand as carriers experiencing the pressure of the pandemic could find the need to better protect their balance sheets while catastrophe risk underwriters may also look to hedge their books of business.

ILS investors may view the hardening market as a sustainable opportunity and feel that the need for greater capacity in reinsurance and retrocessions presents attractive opportunities to deploy capital. It will remain a very interesting set of dynamics to watch as we make our way through the wind season and into the January 1 renewals.  

 

 

Anna Pereira, ILS Bermuda, MANA Consulting, Kathleen Faries, Jo Stanton

Bermuda Re