Welcome to LPI— your new classmate
It is well established that Bermuda is the market-leading jurisdiction for insurance-linked securities (ILS). The Bermuda ILS sector captures in excess of 70 percent of global ILS issuance and Bermuda’s wider alternative capital sector captures approximately 58 percent of global insurance alternative capital capacity.
The ILS market is attracted to Bermuda due to its significant experience in the space, wealth of intellectual capital, a sizeable capital and client base, sophisticated legal system and a substantive and well-respected financial regulator. All of these factors combine to establish Bermuda as a leading jurisdiction and ecosystem for ILS.
But, Bermuda cannot rest on its laurels. Other jurisdictions, such as Singapore, London, and Guernsey, are working hard to increase their market share of the ILS market. Bermuda must continue to innovate and evolve to stay ahead of the game and retain its position as a market leader in ILS, which in view of its nimble and capital-efficient model will only grow in size and relevance as a risk transfer model going forward.
ILS in Bermuda has developed rapidly from its origins in rent-a-captives and cat bonds to the advent of sidecars, to special purpose insurers (SPIs) and more recently transformer/collateralised reinsurance and other fully-funded insurance and reinsurance vehicles.
New directions
The most recent and marked trend in the ILS space is product diversification and the new coverages now available, combined with the heightened understanding by investors of ILS products and their expectations of transparency and improved levels of data and other risk information. Investors are looking for returns outside of the traditional Florida wind cycle of coverage where rates have been static for several years and the 2017 and 2018 losses have been unexpectedly (to some) high.
In the future, or even the present, ILS participants will diversify their risk appetite. Investors are now supporting standalone UK terror, Californian wildfire, US and international earthquake, assorted and exotic weather derivative products and, soon, cyber risks.
Rates are better in those lines and volatility is arguably easier to model and manage. In turn, underwriters and portfolio managers are competing on product, not just price, which can only be a good thing for the viability of the ILS market, which along with the traditional re/insurance market must look to find more penetration in less-developed countries where the protection gap is the greatest.
Bermuda has taken regulatory steps forward to keep up with the changing underwriting appetite and investor demand. When the SPI legislation came into force in 2009 it was introduced specifically to write single-purpose, limited duration catastrophe bond and similar transactions.
While these products and structures remain a key part of the ILS sector the industry has evolved to give birth to more complex structures. We are now seeing more participants making use of leverage and transacting with a greater variety of cedants/sponsors, including unrated non-affiliated reinsureds. This was not within the original scope or thought processes of the Bermuda Monetary Authority (BMA) when the legislation was implemented a decade ago.
Consequently, after consultation with the ILS Taskforce and other Bermuda industry groups—itself a hallmark of Bermuda business collaboration—the BMA perceived a need for supplementary regulation to differentiate those one-cedant/affiliated party transactions from the more complex transactions involving several/unrelated parties.
This has led to the introduction of a new class of collateralised reinsurer, as the BMA seeks to create a new, regulated home for the multi-use and more innovative applications of collateralised and converged capital markets-backed risk transfer products.
The Limited Purpose Insurer (LPI) legislation came in to force in early August 2019. It has been positioned by the BMA as an intermediate regulatory licence sitting between SPIs and commercial insurers but, importantly, it does not require Solvency II equivalence nor all of the additional regulatory hurdles that come with such equivalence.
The right fit
The LPI legislative amendments were made in response to a shift that was already occurring in the ILS market whereby parties were moving away from the SPI regime into the more commercial carrier regimes of classes 3, 3A and 3B.
Our clients tell us that they want regulation, not an absence of it, but would like that regulation to be appropriate and fit for the ILS market they are engaging in.
The BMA is acutely aware of that. As Jeremy Cox, BMA executive chair, stated in an interview at the Bermuda Captive Conference in June, the BMA is: “trying to avoid layers of unnecessary regulation to ensure the framework is adapted to accommodate the fact that we are talking about fully collateralised business”.
The new LPI legislation implemented for collateralised reinsurance in the ILS space will be attractive to the more innovative and sophisticated structures being developed by the ILS market and, in particular, ILS funds, which have led the trend towards diversification of the types of collateral and funding (such as outwards reinsurance/retrocessions) used to back the range of reinsurance business written, which has encroached into longer-tailed risks and other specialised products.
The collateralised LPI class will appeal to those participants for whom perhaps the 3A and 3B classes are overly capital-heavy and bring onerous regulatory filing and compliance requirements. Equally, for those parties writing affiliated business using 100 percent collateralised structures, the existing SPI class remains available.
This new class is not a replacement for the SPI—it is a complementary class that befits the evolution of the ILS market in Bermuda. Some class 3As and 3Bs are likely to apply to change to the new class; some may like where they are and remain with those more classical licence classes.
Solving problems
Whatever clients opt for, the LPI legislation provides the ability to better write long-tailed casualty risks, legacy-capped and retroactive transactions, derivatives and deal with the market problems of clawback and collateral release thrown up by the ILS market model.
The new class of collateralised insurer will also be permitted to transact with unrated cedants, giving them the ability to deal directly with large corporate risk transfer buyers, including government agencies. This would, at least in theory, encourage the growth of the ILS market, which some spectators say is as big as it can be at $100 billion, with other commentators and participants demanding to know why it cannot grow quickly to multiples of that size.
Whatever the roundtables and commentators may say, this new legislation should be seen as a means to allow the ILS market in Bermuda to further develop in scale and complexity and widen its remit as it looks to solve the most complex problems the world now faces, such as climate change.
The legislation is a key indicator that the Bermuda ILS market is thriving and the regulatory framework is continuing to evolve with that demand.
The ILS market has demonstrated its resilience to withstand catastrophic events. Hurricanes Harvey, Irma and Maria (HIM) and the California wildfire events of 2017 and 2018 resulted in the largest loss years for the ILS market and were the biggest tests for the ILS industry to date. The impact of those heavy losses demonstrated again the utility of the ILS model, which met all of its obligations and continues to put in place the structures required to facilitate new issuances.
Capital continues to enter the market at a steady, if slightly decreased, rate. With other domiciles beginning to issue cat bond and collateralised reinsurance structures on a more regular basis, Bermuda’s response to HIM, the California wildfires and the elastic range of products now appearing, was welcome and encouraging.
To further support innovation and development, in late 2018 the BMA launched two parallel innovation tracks: (1) an Insurance Regulatory Sandbox; and (2) an Innovation Hub. These tracks were both targeted at insurtech companies, and complements the digital assets and fintech legislation the BMA has introduced.
The first company to be licensed to operate in Bermuda’s Insurance Regulatory Sandbox was AkinovA, a wholly-owned subsidiary of a UK-based company that trades as an independent electronic marketplace for the transfer and trading of insurance risk.
One of AkinovA’s initial products is said to be focused on cyber risk transfer. Its solution for the Bermuda market is to try to create more liquidity in the collateralised reinsurance market.
ChainThat, a blockchain-driven marketplace platform trading as RiCap (connecting risk to capital) for the transacting of re/insurance business throughout the entire lifecycle of the transaction, from submission to claims, was the first company to join the Innovation Hub.
Finally, with the tremendous growth that long-term, life and annuities reinsurance has seen in Bermuda there is no question that the new and innovative products mentioned above will lead to offerings in the life reinsurance space as well as the casualty space, which to date have generally remained correlated with the traditional commercial carriers in Bermuda.
What is perhaps most interesting about the life sector especially is that, in many respects, the current stage of vast growth and development that the life insurance market now enjoys is reminiscent of the property cat-focused market in 2001 and 2005, and the explosive growth of ILS in Bermuda from 2009. Interesting times are ahead.
Peter Dunlop is a partner at Walkers Bermuda. He can be contacted at: peter.dunlop@walkersglobal.com
Shannon Dyer is a senior associate at Walkers Bermuda. He can be contacted at: shannon.dyer@walkersglobal.com
