9 October 2019ILS

The zebra has spots!

Since we formed ILS Bermuda seven years ago, and held the first Convergence event in Bermuda, there has been not only a convergence, but what appears to be a new “hybrid” animal emerging that looks traditional but acts as if it were alternative–like that zebra that was born with spots.

As the insurance and reinsurance market continues to evolve, change and grow in Bermuda, it seems a good time to look back and also to gaze into the future.

Early days

Back in 2012, insurance-linked securities (ILS) and associated structures, such as sidecars, cat bonds and traditional reinsurers starting their own ILS asset managers, were the talk of the town. Capital in the range of $40 billion had come into the market which felt significant and gave the sense that this asset class would surely grow and Bermuda was the natural fit for this growth.

The groundwork was laid for Bermuda to become the jurisdiction of choice for ILS in 2008 when the Bermuda Monetary Authority (BMA) introduced legislation for the establishment of special purpose insurers (SPIs), which streamlined the process for the incorporation of ILS and brought speed to market. This was specifically designed to attract ILS and collateralised insurance companies to Bermuda.

The legislation came into effect in October 2009 and the Bermuda Stock Exchange (BSX) began listing ILS. At the time, interest in the asset class was growing, and by July 2010 the exchange reached its first major milestone when cat bond listings pushed through the $1 billion barrier. By 2011, ILS listings had passed the $3 billion mark. The $5 billion figure was breached in September 2012.

Yields in the cat bond market were very good from 2013, continually beating out equitites and the S&P index. As investors became more knowledgeable about the asset class, capital continued to be attracted to ILS. Bermuda became the natural fit for this growth due to its location, robust catastrophe market, business-friendly regulatory framework and knowledgeable professionals on the ground. Dedicated ILS asset managers began setting up in Bermuda and the markets that were already in Bermuda turned their sights on how best to work with the capital interest and in-flows.

The Bermuda Business Development Agency’s (BDA’s) first study on Bermuda’s ILS market in 2016 confirmed what those in the industry had known for several years—Bermuda enjoys a dominant position in each of the three key pillars of the global market: insurance-linked fund managers and funds, insurance-linked assets, and service providers that work with both the managers and the assets.

Where are we now?

As of September of this year, ILS listings on the BSX have surged and currently stand at $34.5 billion, reflecting exponential growth. From a standing start in 2009, the BSX is now the global leader in ILS listings with more than 80 percent of global market share outstanding. More recently, foreign listings originating in London and Singapore are listed on the BSX, as many sophisticated investors are familiar with Bermuda’s expertise and regulatory environment.

Fast-forward to 2019 and the vernacular is “partner capital”. As the Association of Bermuda Insurers and Reinsurers (ABIR) aptly declared a couple of years ago, we have converged. Traditional reinsurers are now relying on and partnering with this efficient capital to grow, manage and scale their own operations.

As a result, the majority of reinsurers in Bermuda are partnering with the capital base in some way, either through their own asset managers (eg, Alpha Cat/Validus, Nephila/Markel, Kiskadee/Hiscox, DaVinci/RenRe, etc), sidecars and quota shares, or simply making strategic use of the capacity.

The mission of ILS Bermuda has always been to ensure that the capital and the talent comes to Bermuda. As an industry group, our goal is to grow the business coming to Bermuda and facilitate the development of new innovative risk solution products and expand the risk pie. In earlier days there was some scepticism around ILS and the perception of a potential threat to the traditional reinsurance space. A certain “us against them” mentality prevailed. However, in 2019 the stripes and the spots have formed a new animal and we anticipate this evolution will continue in the coming years. We now have ILS investors starting their own more efficient rated entities, and we have platforms emerging that will likely enable an even more streamlined transfer of risk to capital. All of this is centred here in Bermuda, the hub for innovation in risk transfer.

Bermuda is home to over 20 ILS asset managers and the number is growing. Several asset managers are setting up “captive” rated reinsurers instead of “renting” another’s balance sheet. Cedants view this capital as permanent and trustworthy, a source of comfort after the ILS market was tried and tested by the natural catastrophes of 2017 and 2018, and claims were managed and paid in an orderly fashion.

We now look to this efficient capital base to solve some of the biggest and most challenging risks, and see the opportunity to narrow the amount of uninsured or underinsured risks around the world—the so-called “protection gap” which is estimated to total $180 billion or more. Addressing uninsured and underinsured risks will help to build resilience for emerging and developed countries and corporate entities, as well as driving a sustainable impact.

The securitisation of short-tail lines of business other than property-catastrophe (like terrorism, cyber and auto) also offer the ability to diversify risk by peril while narrowing underinsurance or growing risk. With a sophisticated investor base, growing the pie and diversification are met with interest and collaboration between insurance and capital markets and will promote innovative solutions for big challenges.

A key differentiator between Bermuda and other domiciles is the recognition of Bermuda being a “one-stop shop” as well a proven leader in captive insurance, property-cat, weather risk and now cat bond issuance and collateralised reinsurance. A perhaps lesser-known entity with Bermuda connections is known as African risk capacity (ARC). ARC Insurance Company is a hybrid mutual insurance facility domiciled in Bermuda, and assists African member states in reducing the risk of loss and damage caused by extreme weather events affecting the continent’s populations by providing, through sovereign disaster risk insurance, targeted responses to natural disasters outbreaks and pandemics. Bermuda has the expertise, capacity and ability to deliver a wide range of structures and solutions—from captive formation to collateralised reinsurance and weather derivatives.

Today, investors are more informed as they learn more about the asset class and how events play out. Current hot topics with respect to transactions include issues around loss creep, transparency, trapped collateral, model weaknesses and secondary peril surprises like wildfires. This is precisely the reason we see the annual Convergence event in Bermuda as important to the industry, not only for networking but also for frank and open discussion on current topics.

Where next for ILS?

It is evident that we are beyond convergence. The investor base is committed, educated and ready to move beyond property catastrophe risk. The lines between “traditional” and “alternative” have blurred and even formed something new.

The rapid growth of collateralised capacity has had a dramatic impact on the global reinsurance market. Alternative capacity has assumed a growing percentage of the global catastrophe reinsurance limit and a significantly higher proportion of key segments, such as retrocession and US reinsurance. Collateralised reinsurance has seen the most significant growth.

The BMA is proving itself a mature and forward-thinking regulator as it looks to expand the licensing of ILS-backed vehicles to reflect the evolution and growth of the collateralised reinsurance sector. This year the BMA introduced a new collateralised insurer (CI) class as a result of the increasing scope and sophistication of the ILS and collateralised re/insurance market, including more complex structures and deals.

The view of ILS Bermuda is that we will see a continued push to bring more efficiency to the process of matching risk to capital and investors getting closer to the risk. Innovative platforms have seen success as startups, with the development of seamless technology-driven risk placement with insurance programmes placed on platforms with virtual private data rooms. Insurtech companies are focused on unlocking cyber risk and ILS growth and leveraging their operational experience. Private distributed ledger technology (DLT) initiatives have the capability to revolutionise the way we do business by building efficient, trustworthy, transactional ecosystems.

With the collateralised reinsurance hybrid market continuing to grow and evolve, Bermuda has emerged as the natural leader for this segment because we are an actual market with intellectual capital on the ground and innovation in our collective DNA. We expect to see Bermuda continue to lead in the industry’s transformation.

These are exciting times for ILS and Bermuda promises to be at the epicentre for the foreseeable future. We can’t wait to see what new “animals” emerge!