Smarter cat bond & ILS volatility covers needed. Sidecars one option: ILS NYC 2024

The subject of volatility in re/insurers results due to frequency loss events and the fact they require capital and risk transfer to help them manage this, came up during one of the panel sessions at our recent ILS NYC 2024 conference in New York on February 9th.

The panel session was focused on how to grow the catastrophe bond market further from its currently very strong base and the subject of re/insurers aggregate reinsurance needs, since the elevation of attachment points, was a key area of focus.

The second session of the day at our ILS NYC 2024 conference was moderated by Alex Mican, Head of PCS Global Strategy and Growth, at Verisk Insurance Solutions.

Mican asked the panellists for their thoughts about where the growth opportunities may lie and whether the frequency of cat losses in the United States and elsewhere in the world in 2023 may provide an avenue for prudent growth.

Cory Anger, Managing Director at GC Securities, began the discussion by saying, “I also think that there’s an opportunity. So, the first panel mentioned some comments about concerns about the frequency of losses and I think the theme that I’m starting to see within Guy Carpenter and within GC Securities is, we also need to start really looking at volatility covers. Whether that comes in aggregate, or whether that’s a frequency cover.

“There has been a push to raise retentions generally by the industry, whether it’s ILS or by the traditional market. 70% of North America clients had their retentions raised last year and, since 2014 we’ve had a 125% increase in the return periods in Europe.

“Those are big numbers and so now clients are facing, with higher retentions, concerns about needing innovation and volatility covers.”

Anger further explained, “I think that there’s a way that you can share that volatility, not necessarily first-dollar, but you could share part of it if you’re very creative in the structures, and this whole marketplace has been incredibly innovative in looking at those types of covers.

“So I promote to the community that we continue to focus on that.”

Stephan Ruoff, Head of ILS at Schroders Capital, was also participating in this panel discussion and provided an investors view on assuming more of this risk to help re/insurers in managing losses better.

“I think on the question of frequency risk transfer, I’m of the opinion and this is what we hear from our investors, that frequency cover is not what our investor base is looking for because the modelling uncertainty is relatively high. Hence you have volatility in the outcomes.

“However, the sidecar market, I think, is a brilliant outlet for those kinds of covers,” Ruoff explained.

Continuing to say that this is, “Because there you can align interest between between the reinsurance balance-sheet, or the insurance balance sheet, and the investor.

“The investor base there is a bit different, they can accept volatility, they know what they do, and they know what they take on. There, the question then becomes, is the price right for the risk you’re taking and that’s a completely different discussion than on the cat bond side where you have a different type of portfolio construction.”

Anger of GC Securities then noted that primary insurance rate increases are continuing to get pushed through, but that these take longer to come through to the reinsurance market.

“But that rate action has started meaningfully and I think you’re going to see a lot more profitability come through,” Anger said. “I think that’s an opportunity for the sidecar market as well, to see maybe kind of a resurrection and expansion versus where where it is right now. Which is, there’s still representation of it, but three years ago, it was growing significantly.”

Anger added though, “I think you’re probably 18 months out from significant opportunities, from an investor perspective, in that format.”

The moderator, Alex Mican of Verisk, then asked on frequency and secondary peril risks, whether these are a potential avenue for the cat bond market to innovate and expand?

Anger of GC Securities responded, “I think there are creative ways… I think that you can build the products. The investor community is saying, we don’t want to be first-dollar loss, we don’t want to be close to first-dollar loss, but maybe we will provide smarter volatility covers, but we’re just not going to, you know, nick down as low as that that we might have been.”

Anger went on to discuss so-called secondary perils, saying, “I definitely see the demand among Guy Carpenters client base for enhancing how severe convective storm is covered and how it can be covered and getting capacity and when you get capacity it helps them from pricing.

“But there there is a little bit of a pull-back from an interest in that particular peril simply just because you had larger loss activity.

“But this community has never stepped back when we’ve had large hurricane losses, in fact, we figure out a way to move forward and dive into that. So I think that, for some of these secondary perils, we should definitely not be necessarily pulling back.”

But Anger also noted that not all secondary perils are as well-modelled or as easy to foresee in catastrophe bond form again, in the near future at least, saying there is a “huge difference between severe convective storm and wildfire.”

“It’s these sources of unexpected losses which creates problems for capital markets providers providing capacity,” Anger explained. “They just want to say, I’m willing to take the risk, I just need to understand what the scope of the risk is.”

Adding, “I feel like SCS is one that we can structure and there’s enough history that we can manage it. But wildfires popping up in places that we’ve never thought about, or on risks that we just didn’t think were as meaningful as they were, I think this causes capital to pause on the scope of risk taking taken.”

Ruoff of Schroders Capital also highlighted recent changes in the market dynamic in Europe as possible areas where positive expansion of the catastrophe bond market may be seen.

“When you look at other areas like Europe, what we’ve seen in 2023 is Germany for the first time woke up. For the first time we saw a bond issued in Germany that also covers flood and I think that’s a great sign,” Ruoff said.

“Because for many years the traditional reinsurance market was probably too competitive. With the different issues we had in Europe over the last few years, being inflation on the one side but also loss experience on the other, I think some of the ceding companies are now looking at, how can I diversify my reinsurance panel, but also accept that the pricing differential might be there, but recognise it’s a great source of new capital coming in,” he continued.

Ruoff closed this part of the discussion by saying, “We do see the capital markets, and specifically the cat bond market, being able to address some of the risk that has not been in the cat bond market before. Hence, there is a way.

“It’s not that the cat bond market is not open, it’s just how you structure it and how you model it.”

We’ll bring you more coverage from the event and video / audio of every session will be available in the coming weeks.

Artemis’ next conferences will be ILS Asia 2024 in Singapore this July and Artemis London 2024 in September!

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