ILS investors want to redeploy capital as quickly as a contract allows, despite slowly-developing cat losses. David Benyon reports

The speed at which alternative capital has unlocked and reloaded after last year’s natural catastrophe events has ruffled some feathers in the traditional re/insurance market.

Third parties’ quickness to redeploy capital as cheap capacity has provoked industry acrimony, after collateral was unlocked for investors to move on to their next reinsurance deal – in some cases while cat claims continued to creep up.

“This is what happens after big losses,” one senior London market reinsurance broker told GR. “Collateralised investors  want certainty about losses, as quickly as possible, because they want to release capital tied up with a letter of credit.”

Capital from insurance linked securities (ILS) type deals has reached around $100bn, following Aon’s $98bn estimate at 2018’s halfway point and ILS’s subsequent reloading, fuelled by hungry capital markets investors.

The biggest and fastest-growing segment of ILS-type deals is made up of privately-arranged, single-year, typically-unrated, fully-collateralised reinsurance deals.

This month London-based ILS fund manager Securis Investment Partners outlined its contractual stance in a collateral dispute with Lloyd’s Syndicate 4242, clarifying that contractual wordings meant the ILS provider had no obligation to pay some $13m in reinsurance recoveries being claimed by loss-hit cedants.

“Very often, a contract will stipulate that liability only exists if the trigger point is hit within a defined period and that, thereafter, funds are returned to investors,” said Clive O’Connell, head of re/insurance and partner at legal firm McCarthy Denning.

“Often contracts will provide for an extension of the collateral period if the indemnity losses rise to, say, 50% of the trigger amount but will allow for ultimate repayment to the investor,” O’Connell continued.

“One issue that arose in respect of some 2017 covers was that funds were trapped by 50% provisions even though it was clear that there would be no payment,” he added.

New York-listed Blue Capital Re revealed in October that its third quarter suffered from $6.1m loss creep from Hurricane Irma, more than a year after the storm struck.

Markel-owned CATCo negotiated a collateral release on contracts hit by the 2017 hurricane losses, after boosting loss reserves. The ILS fund was also among those reloading significant new capacity in the summer, adding $700m by July for new buyers. 

Hiscox Re’s underwriting director Megan McConnell warned GR at Monte Carlo in September about “a systemic problem with valuation”, after ILS funds continued to suffer creeping losses, primarily from Irma.

“For the cedants it’s like being in a sweet shop, there are just so many good options,” the London market broker said. “Sellers don’t like that, of course. Many traditionally-minded cedants and reinsurers make the argument that the third-party capital players are undesirable.”

Traditional reinsurers have historically covered cedants following large catastrophes when they might have withheld claims by taking a stricter attitude to wordings, the broker noted. Instead, by allowing an insurer to weather the storm and pay its claims, they were able to buy their long-term loyalty, the broker suggested.

“If that was a hedge fund, they’d have said ‘too bad, we want our money now,’” the broker added.

Some cedants, particularly smaller buyers, eschew ILS deals because of this, except perhaps at the top levels of their reinsurance programmes. Others may look more closely at wordings, particularly for collateralised covers, at upcoming renewals.

“Last year’s cat events will lead people to amend wording and amend the nature of the bargain they strike,” said O’Connell. 

Cedants could also consider whether they want parametric, index or indemnity-based triggers.

“It’s not about fairness, or about reacting to losing money, it’s a case of what the words say,” O’Connell said. “If the protected parties need more fluidity then they will need to pay for that in premium.”

European reinsurance buyers have so far been less affected by collateral release disputes than their American cousins. The bulk of ILS is still focused on US peak cat risks, but European storms are the next best modelled risks globally, and a likely target for expanding collateralised re.

“This is not a new concern in the minds of European buyers,” a senior Continental reinsurance broker told GR. “Those cedants that have moved forward have done so with that in mind. That said, we are looking at making wordings more resilient,” the intermediary added.

O’Connell concurred: “Terms are not looked at closely enough. People will have skimmed through some key terms, rather than investigating fully. Unfortunately disputes come out of these terms.”

ILS continues to play its role in keeping pricing suppressed. Meanwhile traditional reinsurers continue to take advantage of their alternative rivals for cheap retrocessional covers.

“Pour encourager les autres,” the London market broker added. “Every form of capital serves its purpose.”