ILS fund side pockets for hurricane Ian continue to be reduced

We’ve learned from sources that a number of insurance-linked securities (ILS) fund managers have recently been able to further reduce the size of investment side pockets they had established related to hurricane Ian.

ILS fund side pockets are typically established, by ILS fund managers, as a way to segregate assets that are potentially exposed to losses from a major catastrophe event.

They act as a kind of reserving mechanism, while trapping the collateral related to these assets to ensure it is there for payment of any valid claims or reinsurance recoveries.

But, as we’ve reported over the last few months, in the case of major hurricane Ian and the storms impacts in Florida, the side-pockets many ILS funds had established are proving more than sufficient for the eventual quantum of losses that cedents are now reporting.

We reported last November that side-pockets set up by ILS funds for hurricane Ian, focused on private deals and collateralized reinsurance or retro contracts, tended to range from as small as 3% to as much as 30% of a specific strategy.

As we explained at the time, there was every chance some ILS fund managers found that these reserves set against exposed investments into collateralized reinsurance and retro, would find they were set higher than needed, as the claims process played out.

That proved to be the case and when we last reported on this trend, back in January, a number of ILS fund strategies had reduced the size of their side pockets, as greater certainty and lower than anticipated loss estimates for hurricane Ian came out of some cedents.

Which echoed the experience of the catastrophe bond market, where a strong recovery was seen in the months following hurricane Ian, as evidenced by the Plenum CAT Bond UCITS Fund Indices.

At that time, towards the end of January, we were told that some ILS funds had been able to reduce the size of the hurricane Ian side-pockets by between 10% and 25%.

Now, based on insights from Artemis’ sources in the ILS investment community, it appears further reductions in the size of many hurricane Ian side-pockets have been achieved, some much more significant in size as well.

We’ve heard that some ILS fund strategies have seen their remaining hurricane Ian side pockets reduced by anything between 30% to as much as 80%, so a significant recovery and reduction in loss expectations for some ILS fund positions, it now seems.

We keep hearing that these are largely related to indemnity arrangements, both reinsurance and retrocession, with quite meaningful amounts of collateral that had been trapped able to be released back to certain strategies.

The timing of that is quite important, as it could in some cases free up capital for ILS fund managers to use at the mid-year reinsurance renewal season.

Overall, given the recovery in catastrophe bonds and the improvement in loss picture for collateralized ILS strategies, the impact to the ILS market from hurricane Ian has been far less than originally assumed.

It’s difficult to say whether the already improving terms around attachment points helped here, but it seems likely to have in some cases, with more of losses retained by cedents.

Of course, it is still early days for any loss creep related to hurricane Ian to emerge and there remains a risk of that, especially given the Florida landscape remains challenged.

With industry loss estimates still rising for hurricane Ian, there is still a chance of losses rising in some cases as well.

But we may look back on hurricane Ian in years to come and consider it an example of a turning point in how ILS contracts attached to major catastrophe events. Time will tell.