The ILS industry is undergoing an important evolution, away from a purely ‘issuer pays’ model of risk analysis and towards greater emphasis on an ‘investor pays’ approach.
That is the view of Peter Nakada, managing director, capital markets at RMS, who says that an ‘issuer pays’ approach to ILS has been one of the key factors “holding back growth in the marketplace.”
He describes the development towards a more investor centric approach to such transactions as a healthy development for the industry.
Nakada says that the development is important “because of the moral hazard inherent in the ‘issuer pays’ model. We saw this in the financial crisis with the rating agencies.”
“Under the current ‘issuer pays’ approach, issuers get to choose the cat modelling firm and bear all of the costs of the modeling. This arrangement creates the temptation for the issuer to pick the modeling firm that is going to characterise their risk as the lowest. In addition, the modelling firm could well feel pressure to provide results that are acceptable to the issuer.”
Nakada says that the industry would benefit from a shift towards an ‘investor pays’ model. Such an approach has the “incentives the right way around. Investors need to be comfortable that they are getting an accurate view of risk”.
He suggests that investors can also bear some of the burden—both financial and administrative—in bringing further deals to market. This should help to bring further transactions to a market with investors already waiting on the sideline, and would be particularly true of smaller issuers and transactions.
He tells Bermuda:Re that the recent Tradewynd Re transaction issued by AIG was the first transaction to take a more ‘investor pays’-type approach.
“The important innovation in that transaction was that AIG provided us and the other modelling firms with detailed exposure data and allowed us to provide portfolio management insights to our clients that you don’t typically get in a standard risk analysis”.
This in turn enabled clients to understand how the deal would fit within their portfolio, explains Nakada. “And ultimately it made that deal more affordable to issue for AIG”.
Nakada says that there are a couple of other deals in the ILS pipeline that are using a similar approach.
RMS, ILS, alternative capital, cat bonds