Desperate ILS funds doing ‘crazy’ deals in renewals
The prevalence of alternative capital meant the industry’s response to the 2017 losses was very different from the past, with the new capital that entered the industry behaving in a way that was transactional and short-term—and almost desperate in some instances.
That is how Glenn Clinton, managing director, ILS Capital Management, characterises his experience of the last renewals. By way of illustration, he gave the example of when a large insurance-linked securities (ILS) fund pre-committed $0.5 billion of capital for a June renewal on Florida risks in January 2018. There was no negotiation on the rate, he said, despite its being so soon after the 2017 losses which, he suggested, smacks of desperation.
“Money has always poured in after big losses, but a portion of this ILS money behaved very differently from the outset; there was a very different dynamic at work,” Clinton said.
“There was a certain desperation to employ it; no-one wanted to give it back. Consequently, it became transactional, and it looked as though it had a short-term focus.
“Can you imagine a balance sheet reinsurer committing half a billion dollars of capacity six months in advance at expiring rates after a year like 2017? That is a dynamic that just would not happen.
“The claims were still pouring in; the Hurricane Irma incurred number was soaring and a programme renewed six months early at flat rates. In fact, three funds banded together to give $1.5 billion of capacity on that $2 billion June placement six months early. The broker had threequarters of it done at expiring pricing with Irma still soaring.”
He added that a former boss, the chief executive of a $1.2 billion reinsurer, did not believe him when he relayed what was happening.
“So here we are, after a minimal Florida rate increase in June, after having absorbed $26 billion Irma (and Harvey and Maria to boot) we are facing Michael, after Florence has taken out the underlying layers to send the loss straight into the reinsurance market.
“You can’t make this sort of thing up. It’s absolutely crazy.”
In this context, Clinton also gave a somewhat bleak perspective of the outlook for the market, specifically the thesis that the prevalence of risk models has put an end to the cycle and the concept of ‘payback’ in the aftermath of a big loss.
He said that in 30 years of writing North American property business, he has rarely known a period where he has so little rate for so much exposure.
“Yes, there was a minimal rate uptick in 2018 but that does not make up for 12 years of a generally downward curve,” he said. “I am a few points above the worst rate I ever had at the bottom of the market in 1999.
“Exposures are up, sums insured are higher, insurers are permitted to keep smaller retentions and our reinsurance contract terms are very soft. Just step back and look where we are—look at the state of the market. I am not looking for rate stability down here, I want more rate, period!”
Clinton hopes that some of the predictions of his peers come true and the market will eventually turn. He noted that Stephen Catlin’s recent prediction, that reinsurers’ cash flows will be under pressure and even negative for some carriers in 2019, could turn out to be true.
“When cash dries up, CEOs will start putting pressure on underwriters to achieve rate. That’s the only place money comes in quickly. That leads to fear, and fear is a powerful motivator.
“When underwriters fear for their positions, they will find discipline quickly, or be gone,” Clinton concluded.
He also referenced comments made recently by Jed Rhoads, chief underwriting officer of Markel’s reinsurance division, who compared the industry to lemmings—he hopes that at some point they learn to stop jumping over the cliff.
“Jed put it beautifully this time last year. There’s a herd mentality in this business—there have always been leaders and followers,” Clinton said.
“At some point some members of the herd decide to not jump over the edge. I’m hopeful that we are there and that some of the larger more influential members of the herd decide enough is enough.
“We have an inelastic product, where demand stays the same regardless of price. Primary insurance clients who need our capital to execute their business plans spend the same on reinsurance year after year.
“It’s a budgeted amount, somewhere between 14 and 17 percent of their GWP on average. It does not increase after bad cat years, because it cannot.
“We need to force them into greater retentions, to have a greater alignment of interest. We need to tighten terms and conditions, we give far too much cover today. And we need them to pay more for what they are buying, it is that simple.”
Trust in cash
One consequence of these pressures in the market, however, and specifically the ill-discipline of some ILS funds could be a flight to quality whereby investors prefer to trust their cash to funds that are more discerning in their approach.
“It’s my hope that investors in the ILS space will be more selective, more discerning in where they put their money,” Clinton said. “Do they want a fund to just get the money out to work or do they want one that provides them with alpha, one that will have them invested in better quality business?
“At ILS Capital, we take a much more qualitative approach in what we do. We target specific accounts, tier one companies with which we have had strong relationships in former jobs. We have strong analytical capabilities and we are small relative to our peers (just under $400 million assets under management), meaning our growth is very controlled.
“We do not get involved in large capacity plays, we need to be important to the relationships we have.”
He added that most reinsurers are also keeping a close eye on cost, which will both trigger more consolidation in the industry and potentially mean more growth for the ILS sector.
“M&A will continue as balance sheet reinsurers seek cost efficiencies. Some of the multiples we’ve seen this year are staggering. Bigger is better and the ensuing cost efficiencies seem to be the drivers in this flat / poor rate environment. And that’s why ILS will continue to grow, our cost structures are a fraction of the reinsurer.”
Clinton said he is also seeing a trend for placement platforms gaining acceptance, which will drive production costs down and create efficiencies.
“However, while sorely needed, each additional tier between me and my client decreases my comfort level. I get comfort from seeing the whites of a client’s eyes, understanding his underwriting philosophy and his underlying business.”
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