Residual markets are a result of inconsistent price signals


Residual markets such as in Florida are a result of inconsistent pricing signals from traditional reinsurers. Convergence capital can help to smooth rate changes and in turn reduce the regulatory burden. 

That is the view of Frank Majors, partner and co-founder at Nephila Capital, speaking at Convergence 2013 in Hamilton, who said that rate spikes post-event have helped to increase the regulatory burden faced by the industry and encouraged state involvement in the coverage of cat risks such as US flood and earthquake.

Majors said that alternative capital can help to smooth sharp price increases post-event and drive greater demand for private market solutions on risks that currently reside with governments. He added that price consistency would instil greater confidence among regulators, which would help to head-off any increase in oversight.

Anthony Rettino, founding principal and portfolio manager at Elementum concurred, arguing that the stability afforded by alternative capital is a major attraction to the market. “If you asked people whether they would pay more for stability in price, most would say 'yes'”

Here to stay

Addressing the longevity of investors interest in the convergence space, it was apparent that losses and the interest rate environment are unlikely to derail the ILS market. As Kean Driscoll, CEO of Validus Re outlined, the industry has seen a three-fold increase in size since 2001, adding that the weight and durability of the ILS market is only set to increase. 

Rettino said that his investors are spending considerable time in due diligence and are increasingly sophisticated. Majors was of a similar view, stating that of Nephila's ten largest investors, none of them is allocating more than 0.5 percent of their portfolio to cat risk. As such, he questioned how hurt such institutional investors could be post-event. 

Not that there aren't naïve investors in the space. It is just their number is diminishing, the panel said. Majors cited AIG's Tradewynd Re and Citizens' Everglades Re cat bonds as cases in point, with interest in AIG's more complex deal, far less marked than in Citizens relatively simple bond. He said that this in some way reflects investor understanding of the ILS deals coming to market.

Proximity to risk

Addressing the issue of distance between risk and capital, Majors was robust in his defence of ILS structures. “I challenge the contention that there is greater distance between risk and capital in the ILS space”, he said. Pointing to the New York MTA's MetroCat deal, he said that it connects the issuer direct with investor capital, whereas in a traditional deal there are a host of intermediaries. 

Rettino agreed that there is a higher degree of understanding of the risks that they are taking on among Elementum's investors than those that invest in equity structures.

More risk needed

However, there were some notes of caution concerning the ILS space. Majors agreed that the market is “at an inflection point”, adding that Nephila has been obliged to “turn off the taps to new investors”. He said that the company was “taking a breather”, adding that it was “nothing of concern”, but said that the industry should be looking to unlock new risks such as those currently residing with state-backed entities such as Citizens.

Driscoll likewise spoke of the need to bring additional risks into the ILS space, citing TRIA, the NFIP, California earthquake, and property demand if Fannie Mae and Freddie Mac are privatised as being areas of interest. He said that this would help to prevent convergence capital channelling into a narrow risk band that is inevitably placing pressure on pricing, both in the alternative and traditional reinsurance space.  

Kean Driscoll, convergence capital, Frank Majors, Nephila Capital, Convergence 2013

Bermuda Re