Almost a year ago, what would eventually become known as the ‘George Floyd’ riots began – an event that would eventually cost the global insurance industry more than US$2 billion. Since then, more than US$1 billion in protection for riot and strike, riot, and civil commotion (SRCC) has been removed from the market, and there’s a sense that underwriter resistance to SRCC could continue for a while. As the ‘peak peril’ period for SRCC continues, the re/insurance industry should be looking for more ways to provide capacity for the risks that significantly affect society. Unfortunately, that’s tough to do without underlying deal economics that make sense.
Some support could come from the insurance linked securities (ILS) community. In fact, through the summer of 2020, the PCS team heard from several re/insurance underwriters that they believed ILS capital could become an important part of the solution. Of course, this comes up a lot. When there’s a thorny risk that the traditional market struggles with, a rising sentiment to ship the risk off to the ILS folks tends to follow. This tendency can often mask real opportunities to source new capital – and what the industry will have to do to make such allocations possible.
To get a sense of what it would take to help the ILS market assume SRCC (and other forms of political violence) risk, PCS®, a Verisk™ company, spoke with 15 ILS funds. Representing more than 60 percent of the industry by assets under management, we sought to help the market understand why ILS funds have avoided SRCC and what it would take to help them deploy meaningful amounts of capacity to the risk.
Of the 15 respondents we engaged, a mere three said they had explicit restrictions regarding SRCC and other forms of political violence. And even for them, the constraints were only relevant to some of the funds they manage. Consequently, PCS concludes that only a single-digit portion of the roughly US$60 billion in capital participating in our research project would have explicit prohibitions on political violence.
Further, we learned that only four ILS funds currently engage in SRCC and political violence trading on a standalone basis (or have done so recently). Two of them said they’d be open to SRCC and political violence trades but have avoided the sector for specific reasons (such as a combination of deal structure and price). A fifth ILS fund would be willing to take a look at standalone political violence but doesn’t think the pricing could reach appropriate levels, while a sixth said “It’s a risk we quite like,” but that they’d need to see “more sensible structures.”
The interplay between price and structure was a common theme in our discussions with the ILS funds who supported PCS’s research. Either the rates paid weren’t sufficient relative to the structures provided or vice versa. As with any transaction, there needs to be a balance between compensation and the likelihood of loss. SRCC and political violence transactions have yet to find that in the ILS market.
Perhaps more difficult than the issue of rate/structure balance, according to our respondents, is the difficulty involved in modeling and quantifying SRCC. A lack of independent models slows the process of capital markets adoption of SRCC risk, and a paucity of historical loss events (only 13 in the United States since PCS started keeping track, with only two over US$100 million in industrywide insured loss) frustrates in-house actuarial efforts to understand SRCC.
Despite the impediments to SRCC risk trading, some funds did indicate an openness to the class of business, as long as they could compensate for the extra uncertainty – mostly via uncertainty loads and novelty premium. In fact, PCS learned of two ILS funds that were open to trading riot and civil disorder risk in the fourth quarter of 2020. Both would have traded as buyers or sellers but were unable to find trading partners because of the short turnaround time involved. The trading appetites contemplated the potential for SRCC following the U.S. presidential election in early November. However, additional barriers to trade completion were the lack of comparable historical events and the approvals necessary for unorthodox underlying risks.
The ongoing climate of civil unrest in the United States and around the world requires creative action to provide sufficient protection to existing and potential insureds while not jeopardising financial performance. The ILS market could provide retrocessional support that would translate to underwriting flexibility all along the risk and capital supply chain, but capital allocation requires discipline. The good news is that small steps today can make a profound difference tomorrow. And today’s incremental progress could come in the form of simply learning more about SRCC risk and how it manifests. Developing a body of knowledge can make it easier to explain deals and get approvals faster, especially for the one-off trades necessary in the near-term to provide a platform for future market scalability.