At a pivotal point
The insurance-linked securities (ILS) market is at an interesting point in its existence and, as it develops further, it has real potential to shape not just the risk transfer sector but also the wider world for the better, believes Greg Wojciechowski, president and chief executive officer of the Bermuda Stock Exchange (BSX).
Wojciechowski says that the past seven years have been fascinating in terms of the way the sector had grown and developed.
“The BSX entered the market just after 2008,” he says. “We thought that there was an opportunity to help accelerate substantive convergence. It was widely reported that there was an exposure gap in the world and there was a firm understanding that capital was going to need to enter from the capital markets address the exposure. It wasn’t necessarily going to be the insurance industry covering risks entirely.”
He says the BSX realised there was an opportunity to help facilitate the process of matching this capital with risks. But there was also a bigger vision, Wojciechowski explains—the understanding that the industry could help vulnerable populations.
“The capital markets, including regulated exchange platforms, create the bridge, the transformation vehicle, to move that capital from where it sits right now to where it needs to be,” he says.
“This is a really interesting time to be involved in an industry that can do some good. We can make money, but we can also provide coverage and support for places that are developing and populations that are vulnerable.
“That’s going to come with capital moving in to narrow the exposure gap and through structural changes in emerging areas to better facilitate coverage. What we’ve seen at the BSX has been an acceptance of investors in investing in insurance-related products and market conditions have supported that for those interested in alternative investments.”
As a result, Wojciechowski says, ILS has been perfect for this demographic of investor. As a non-correlated asset that offers a yield play this asset class is a unique investment portfolio diversifier.
“We’ve watched our business continue to grow since we started supporting the asset class. At this point, our support is limited—we’re providing listing services for structures to provide transparency around that structure,” he says. “Over the last few years we’ve watched the asset class begin to evolve organically and believe that there is an opportunity for more exchange involvement.”
"Convergence is actually happening and we will see capital enter those areas where it’s needed the most and being deployed in a way that can be most useful.”
At the BSX, 142 ILS vehicles are now listed with a total market capitalisation of around $17 to $20 billion. Wojciechowski says this is a very high proportion of the total market size globally, which is about $24 billion.
“The BSX has great market support. At present we are listing the lion’s share of issued cat bond structures which makes us happy but we believe that we can add additional support to help further develop the asset class,” he says.
The trajectory of the pure cat bond market has slowed in recent months, which some attribute to the pricing of this sector having reached a floor. Wojciechowski acknowledges this trend but notes that it is true of only some parts of the market.
“It’s true that the issuance velocity of cat bonds has eased off a little, but it hasn’t eased off in other areas of ILS—collateralised reinsurance has actually increased over the last year,” he says.
“That’s a really interesting indicator that the capital markets have become a lot more comfortable with investing in risk transfer vehicles. And this is an excellent time in the history of our two markets. Convergence is actually happening and we will see capital enter those areas where it’s needed the most and being deployed in a way that can be most useful.”
Finding new risks
One of the challenges faced by the market, according to Wojciechowski, is finding new risks for investors to invest in. Most of the issues the BSX has seen are property-catastrophe related, with the majority being US-centric.
“We’re starting to see some diversification, which is a good sign,” he says. “It may not be as fast as everybody wanted, but we’re seeing regional diversification. The BSX has listed bonds linked to the Turkish Catastrophe Insurance Pool, which covers Turkish quakes, and we’ve seen another deal transferring risk in relation to Italian quake activity.
“The first China deal, from China Re, has come to Bermuda and is listed on the BSX, which was significant as it is an indicator that the Chinese market is beginning to better understand the use of risk transfer vehicles and how these can further support that region’s insurance needs.
“Everyone wants the market to develop quickly, but if we look at where the industry/asset class was in the 1990s compared with where it is today, there’s been some phenomenal development and I think it’s going to continue.”
According to Wojciechowski, the next step will be the creation of a platform that allows investors to exchange risks while also offering the next level of comfort, oversight, price discovery, distribution capability and accessibility for the secondary market.
However, he adds, it is impossible to predict when this might happen. “If we look historically at the capital markets and platforms that have attempted to penetrate the space there have been failed attempts at achieving exchange-traded vehicles.
“Perhaps it’s been market conditions, or market appetite, but success has been elusive.
“Eventually though the structure of the market will move to something that is more efficient and that will underpin investors being able to move more fluidly in and out of the secondary market.”
Wojciechowski acknowledges that there is a lot of work still to be done in the market and in respect of market structure.
“All the pieces currently exist and there is real potential to build an exchange-tradeable risk transfer market, but there’s a lot of work ahead,” he says. “There is the discussion of unlocking original risk to create diversification, but structural work at the ground level will be required in order to do this and to deliver new sources of risk to be transferred.
“Alongside that will be the mechanics that will be needed to create a solid exchange platform to encourage more fluid entry into and exit out of vehicles.
“That said, this should be seen as an opportunity rather than a barrier to making it happen.”
Optimistic for the road ahead
Wojciechowski says that the market is generally optimistic about its development, even if the amount of money flowing in from the capital markets were to change.
“It is felt that ILS has become, certainly from an investment perspective, a nice portfolio diversification strategy, and investors have become more comfortable with the asset class,” he says.
“Seven of the world’s biggest cities are in Asia and the largest amount of exposure gap exists in that segment of the world."
He also believes that ILS investors have become increasingly comfortable and sophisticated in their understanding of the risks involved in investing in these structures, but there is always work to be done in making sure the market continues to deepen its understanding of the vehicles and investment risk involved.
At this stage the investor demographic tends to be institutional investors or high-net-worth individuals and not retail investors.
“Investment funds are getting more skilled at understanding the asset class and the associated risks and they’re putting excellent resources in place to address these.
“I feel there has been a commitment in the capital market to understanding the asset class and a realisation that the asset class has longevity and is simply not a passing trend,” he says.
Wojciechowski adds it will be interesting to see how the market develops in the context of market cycles, both in the capital markets and in the re/insurance sector.
“When you talk about market cycles, if we were talking about this asset class pre-downturn in 2008, the capital markets would have been hard-pressed to understand the dynamics of the asset class in the face of investment performance that could be achieved elsewhere.”
As investment conditions change, the dynamic in the sector will also change. “The market may be more demanding now and that’s a good thing for a developing market,” he says.
“The market is continuing to expand thanks in part to capital entering the space and coverage is being expanded to places that it hadn’t been before. I’m really interested and excited to see how this development helps not only grow the industry but assists places and populations that are in need of coverage.”
While Wojciechowski agrees he does not have a crystal ball, he believes the industry will increasingly gravitate towards exploring new risks and risk mitigation in developing economies.
“You have to look at what’s needed and why,” he says. “Many developing economies, economies that are mid-stream in their development, have risks that need to be covered, whether for their own protection or for their continued development.
“Twenty years ago those economies might not have had that robustness, so there’s a whole new market there.”
Wojciechowski also hopes for a lot more interest and business from China, and Asia as a whole.
“Seven of the world’s biggest cities are in Asia and the largest amount of exposure gap exists in that segment of the world. To me it’s fairly intuitive that when you look to provide additional support in the markets, those are the countries, cities and industries that actually have created capacity for services and they’re going to look for that.
“That’s where you’re really going to see some interest.”