Bermuda leads in ILS innovation

Bermuda remains the leading jurisdiction for the issuance of catastrophe bonds. Insurance-linked securities (ILS) issued from Bermuda represented 76.1 percent ($22.5 billion of $29.5 billion) of total outstanding capacity at the end of Q2 2017. Since 2010, 185 Bermuda-based special purpose insurers (SPIs) have been registered and have issued 187 ILS deals.

The importance of capacity provided by the ILS markets is now well understood by most working in the risk transfer industry. And it is becoming ever more important. In 2017, the catastrophe bond market reached a new record in 2017 with a combined total capacity of $10.7 billion, according to an Aon Securities report.

The Insurance-Linked Securities Year-End 2017 Update report reveals that during 2017, 35 catastrophe bonds were issued by 31 different sponsors.

The previous annual issuance record of $8.38 billion, established in 2007, had already been surpassed by the end of June, following a first quarter issuance of $2.2 billion and a second quarter issuance of $6.4 billion. This first half total of $8.6 billion was then augmented with a third quarter issuance of $0.8 billion and a fourth quarter issuance of $1.3 billion.

As at December 31, 2017, the capacity of all catastrophe bonds active in the market, also known as catastrophe bonds ‘on-risk’, totalled $25.7 billion—another new record—while alternative capital had reached a record $89 billion.

A leading role

Within this picture, Bermuda plays a dominant and critical role. As well as being the clear domicile of choice for ILS—some 75 to 85 percent of all ILS are based on the Island depending on how you count deals—it is also driving the market forward in terms of innovation.

This is where the future of ILS will head, according to commentators. Investors’ appetite for US windstorm and earthquake risk will still be there—but the real breakthroughs will be made by working out new ways to move risk into this market—and finding new risks that can be moved.

Paul Schultz, CEO of Aon Securities, says that while 2017 was a record year, he expects the scope of the market to broaden.

“The ILS market had a very strong 2017, with several new records being set and alternative capital rising to new heights in the reinsurance marketplace,” says Schultz.

“We expect to see a gradual broadening of the scope of ILS products, making them an even more common risk transfer tool for re/insurers, with continued support from investors for this diversifying asset class.”

This will drive further growth in the market. Aon Securities forecasts catastrophe bond issuance for 2018 will be approximately $8 to $9 billion. Schultz believes that momentum is on the side of the market in 2018—partly because of the way this form of capacity stood up to the big wind losses towards the end of the year.

“2017 was an extraordinary year in terms of catastrophe losses and ILS issuance, and as we move into 2018 there is a great deal of momentum for ILS. Historically, one of the big issues for ILS is being characterised as an untested source of capacity when compared to traditional reinsurance,” he says.

“In the wake of the largest ever loss-causing year, ILS rose to the occasion and continued to prove to be an efficient source of capital, further demonstrating its value to the reinsurance market. This ILS momentum, we believe, will continue through 2018 and will be a ‘rising tide that lifts all ships’—ie, all forms of ILS.”

The potential growth of this sector might be seen in the statistics for new registrations on Bermuda in 2017.

Bermuda Monetary Authority (BMA) statistics show that 58 re/insurance and ILS vehicle registrations took place in 2017, a big increase on the 42 registered in 2016, reflecting growth in the ILS and collateralised reinsurance markets and other sectors. These also helped to grow the ILS registered on the Bermuda Stock Exchange (BSX) to a new high of $26 billion.

This is good for Bermuda. The Bermuda Business Development Agency (BDA) suggests that these vehicles are also creating jobs on the Island and boosting the economy in the process.

Greg Wojciechowski, BSX president and CEO, and ILS Bermuda Chair, commented on the ILS activity in Bermuda in 2017. “New ILS listings on the BSX totalled 103 securities for the year, with a nominal value of $11.54 billion. This represents annual growth of 69 percent in the number of new securities listed, and 87 percent growth in the nominal value.

“Bermuda’s global market share reached record levels of approximately 84 percent, cementing Bermuda’s continued position as leader in this innovative asset class. The devastating natural catastrophe events in 2017 demonstrated Bermuda’s resilience and its tried and tested infrastructure, as well as expertise in the property and casualty space,” he said.

Innovation in abundance

Those who believe innovation will now drive this market have reason to be bullish. A number of announcements and ventures have already come to light in 2018 with the potential to continue to expand the scope of ILS and further establish it as a mainstay of risk transfer as a result.

A good example of this was when MultiStrat Advisers, the Bermuda-based total-return reinsurer and servicing company, offered an insight into the traction it is gaining structuring so-called casualty-linked securities (CLS)—a form of risk transfer known to be growing, although many of these transactions are private.

Giving details of a recent deal, MultiStrat Advisers, operating alongside Bermuda Class 3A insurer MultiStrat Re, said it had completed a CLS transferring high-frequency, low-severity casualty business backed by a $14 billion global alternative asset manager.

It said that during the programme, the investor will invest $28 million in a Bermuda-based segregated account to support total liabilities associated with $160 million in estimated written premium.

MultiStrat Advisors and MultiStrat Re (collectively MultiStrat) arranged and conducted due diligence for the transactions. MultiStrat Re and its Bermuda-based partners will service the transactions. Storm Harbour Partners acted as the placement agent.

MultiStrat indicated that this deal is just the tip of the iceberg. It said that in the past 12 months, it has completed multiple CLS transactions with estimated premiums of $230 million and total capital investment of $60 million.

It said the investors in these include alternative asset managers, specialised insurance funds, and established reinsurers. Classes of business covered to date include workers’ compensation and related healthcare liability, employers’ liability, professional liability and personal auto liability.

In mid-2017, the company also  revealed details of deals it had done alongside Hudson Structured Capital Management, transferring the risk of workers’ compensation liabilities.

Bob Forness, CEO of MultiStrat, said: “We are pleased to expand our CLS offering with world-class backers to cover both retrospective and prospective casualty reinsurance transactions. Delivering reinsurance opportunities to investors in a competitive market demonstrates the potential for CLS in the broader markets.”

Jim Robinson, CEO of MultiStrat Advisors, added: “We are pleased to continue our innovation in the CLS market. The collateral backing these transactions will be actively and conservatively managed by investors to produce incremental investment income.

“This total return profile is appealing to a broader population of investors seeking yields with less volatile, non-correlated reinsurance results.”

There has also been innovation in the geographic scope of some of the ILS that have come to market. Brazilian reinsurer Terra Brasis Resseguros has renewed a cat bond that provides it with protection against certain types of property-catastrophe risk in Latin America on an indemnity basis. This had been done before, but this deal expanded the size and scope of the coverage.

Alpha Terra Validus II, a $5 million private catastrophe bond transaction, was underwritten and invested by AlphaCat Managers, a subsidiary of Bermuda-based Validus Holdings. The deal renews the 2017 Terra Brasis Validus I transaction.

The renewal transaction has also been issued through a segregated account of White Rock Insurance (SAC), which is managed by Aon Insurance Managers, Bermuda. The notes were admitted to the BSX as of January 15, 2018 and will remain listed there until maturity.

Lixin Zeng, the CEO of AlphaCat, said: “We are pleased to continue our successful partnership with Terra Brasis Re and look forward to working together in the future.”

Rodrigo Botti, director of Terra Brasis Re, added: “ILS-based solutions are gaining momentum in Latin America, with recent issuances of different size and scope. We are pleased that our close partnership with AlphaCat continues to contribute to the development of this technology in the region.”

Innovative ILWs and driving M&A

MultiStrat Advisers has not been alone. Bermuda-headquartered Hiscox has also launched an innovative new product this year in the form of the first ever cyber industry loss warranty (ILW) product to help address the uncertainty around cyber tail risk for re/insurers.

The new cover responds to an aggregation of cyber losses throughout the year. Hiscox said it can act as an effective hedging mechanism for cyber underwriters. The size of the market loss will be determined by the PCS Global Cyber Index.

ILWs allow an organisation to take out coverage based on the total insured industry loss, rather than the losses of a specific insurer. While ILWs are common within the property reinsurance and retro markets, Hiscox’s is the first that responds specifically to cyber losses.

Mike Krefta, Hiscox Re ILS CEO, says: “We have big ambitions in cyber and our new cyber ILW is another important step forward in developing that market. We believe innovations like this demonstrate our technical abilities and willingness to be a market leader in emerging risks.”

Meanwhile, Hiscox has also been investing in talent. Bermuda-based Hiscox Re Insurance Linked Strategies, the ILS asset management arm of Hiscox, appointed Ben Fox as portfolio manager earlier this year.

Fox joins Hiscox Re ILS from Ontario Teachers’ Pension Plan, where he served as principal of ILS since July 2014. In this role, he co-managed the Plan’s ILS portfolio and was responsible for all analytics including portfolio construction and optimisation capabilities.

Movers and shakers

There are other developments in the ILS space to watch with interest. American International Group’s (AIG) move to acquire all outstanding common shares of Bermuda-based Validus Holdings will be watched with interest by the ILS community because it gives the world’s largest insurer a foothold and access to third party capital.

This was not lost on analysts who noted that the transaction enhances  AIG’s general insurance business, and adds a reinsurance platform, an ILS asset manager, a presence at Lloyd’s and complementary capabilities in the US crop and excess and surplus (E&S) markets.

AlphaCat specifically manages $3.2 billion on behalf of clients by investing in ILS products. A number of analysts noted that this gives AIG access to a very different market and the deep pockets of capital markets investors—and these operations are Bermuda-based.

A similar theme emerged when AXA acquired XL Group. The deal represents a big shift for AXA, changing the mix of its business. P&C business represented some 39 percent of AXA’s 2016 pre-tax underlying earnings. After adding the XL Group and excluding AXA US, which is set to be sold, P&C will represent around 50 percent of its pre-tax underlying earnings.

The company has acknowledged the reach this gives AXA into a new source of capital.

AXA CEO Thomas Buberl noted that AXA wants to retain the reinsurance business not least because of the access to financial markets it enables.

Gregory Hendrick, XL chief operating officer, explained that a focal point of the reinsurance business is alternative capital as pension funds, sovereign funds, high net worth families want to participate in the property/catastrophe risk market.

“XL Group wants to bridge the gap between the traditional reinsurance and insurance market into that alternative capital space,” Hendrick said. “Thomas and Mike (XL Group CEO Mike McGavick) see a big future on the growth of that potential. That’s one of the big things that the reinsurance operation brings to the table,” Hendrick added.

For those considering what innovation and ILS will truly mean going forward: watch how big companies like AIG and AXA bring their new found access into this market. The chances are they will be doing whatever they do on Bermuda.