Convergence 2020 report

The growing pains of ILS

The year 2020 could come to be seen as the year that ILS came of age. Having experienced a significant shock event in 2020, in the form of COVID-19, it has proved itself in a challenging market, but it is not yet fully mature. Bermuda:Re+ILS reports.

Insurance-linked securities (ILS) is no longer a child that can be forgiven repeated bouts of immaturity, but nor is it yet a mature adult. It is, according to Cate Kenworthy, head of investor relations and business development UK at Securis, enduring adolescence, and is experiencing the growing pains typical during this stage of development.

Kenworthy was one of many speakers at Convergence 2020 discussing the challenges faced by the ILS industry, and how it might navigate a path forward to greater maturity and, ultimately, investor acceptance.

Robert Howie, principal at Mercer, warned that ILS managers need to think about culture.

“When comparing the cultures of insurance companies with that of asset managers, for me it is a red flag when I meet an ILS manager who refers to counterparties and cedants as ‘clients’,” he said. “The investors are the clients.”

“It is a red flag when I meet an ILS manager who refers to counterparties and cedants as ‘clients’.” Robert Howie, Mercer

The point underscored the unique position ILS occupies at the intersection of many different elements of the r/insurance industry.

Andrew Hughes, managing principal and Hiscox partner at Hiscox ILS, said ILS managers must reconcile the challenges of being both fiduciary asset managers and reinsurers. Managers have a responsibility to do the best they can for their investors, while accepting they are a small part of the reinsurance market, with relatively limited influence over it, he said.

A number of speakers highlighted questions of transparency, which ILS managers were urged to prioritise.

Howie said: “ILS is a simple product with a compelling message and many fantastic properties, but ILS managers make it sound complicated and use too much jargon.” He advised ILS managers to improve their communication skills to stop scaring away investors.

James Turner, investment manager at RPMI Railpen, noted that in many cases ILS constitutes a small part of an investor’s portfolio. If it seemed excessively complex, many investors would not bother, he said.

“I would emphasise diversification more than absolute returns, and steer boards away from year-on-year relative value judgements versus other investments,” Turner said.

More clarity

Howie emphasised the importance of avoiding nasty surprises. While returns are inevitably unpredictable, he noted, the way managers respond does not need to be. Managers should be clear about their policies around issues such as sidepockets and valuations, so that investors know what to expect.

The same is true for succession planning, Turner said, advising funds to think—and communicate—about it early, to avoid surprising investors.

“My advice is for managers to be honest with investors and share their plans early,” he added. “Investors will understand if things change.”

However Craig Adkins, associate partner for alternative investments at Aon, warned that the talent pool for ILS managers is not as deep as the one for hedge funds, which could make succession planning more challenging.

Howie noted transparency had improved for investors during 2020, with the lack of business travel ensuring managers and investor relations executives were more available than usual.

However, Bernard Van Der Stichele, portfolio manager for ILS at the Healthcare of Ontario Pension Plan, warned this may not last forever, noting transparency often increases during a hard market, but often changes back quickly once the market turns.

Transparency is not the only issue of concern to investors, noted Adkins. “Long-term investors have been exasperated by the continual need for more cash,” he said. ILS is competing against other opportunistic strategies, he noted, and if there is a high level of trapped capital, investors may prefer to allocate elsewhere.

“My advice is for managers to be honest with investors and share their plans early.” James Turner, RPMI Railpen

A number of potential solutions have been floated for the trapped capital issue, including banks or distressed debt hedge funds stepping in to offer credit lines. One ILS manager has also securitised trapped capital.

Dominik Hagedorn, co-founder, chief executive officer and head of investor relations at Tangency Capital, warned these solutions may come at a price. Distressed hedge funds may not be willing to offer liquidity on the terms ILS managers want it, while the cost of capital with a bank may not be attractive.

While these solutions do offer options for ILS, it is not clear whether these decisions should be approved by investors, or whether managers could make these decisions on behalf of investors, added Hughes.

Jason Rector, managing analyst at the State of Wisconsin Investment Board, argued that including other perils in ILS would help with the trapped capital issue. Making relatively small allocations to other perils such as cyber ILS would increase portfolio stability, he said.

Rector stressed that property cat remains an attractive asset class, but insisted investors needed more alternatives in the ILS market. With property cat being the only peril offering significant capacity in ILS, investors are left as price-takers, he warned.

By opening up ILS markets for other perils, investors can be more opportunistic and look for relative value, Rector explained.

Paul Barker, partner and portfolio manager at Elementum, noted losses from secondary perils have been a huge issue for ILS. According to Aon statistics 60 percent of ILS losses have come from secondary perils in 2020, while secondary perils have driven the majority of losses for ILS in eight of the last 10 years, he said.

Images: Palamarchuk

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October 2020

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