Trapped capital can be solved: ILS Capital MD Clinton

After several years of heavy losses and other unexpected challenges such as loss creep and trapped capital, insurance-linked securities (ILS) investors are much more cautious going into the year-end renewals, with many readjusting their portfolios and attempts being made by some to solve the problem of trapped capital.

That is according to Glenn Clinton, managing director, ILS Capital Management, who told APCIA Today that, while few are ready to walk away from the sector, three years of extraordinary catastrophe activity on the trot has made them pause for thought.

“We’re about to complete the third year in a row of their grappling with trapped capital and loss creep from Hurricane Irma in 2017 and Typhoon Jebi in 2018.

“Investors with Japanese exposure in 2019 will shoulder some significant losses. For two years in a row we have seen two very powerful typhoons follow near-identical tracks, with an earthquake both years as well,” Clinton said.

“What they have had to deal with has been beyond belief and, with the latest events in Japan, they will not know the full impact until the March renewals next year, if then. Think about how stretched loss adjustment resources in Japan must be at this moment.

“I think loss adjustment expense and demand surge will again be an issue. Investors have had a very difficult time. They are still interested in the space but there is a growing understanding that they have to develop the stomach for these losses. They must be brave and optimistic, but money is certainly not pouring in at the moment.”

Clinton said this will mean a tightening of capacity, especially in the retro space.
But he stressed that he does not expect a shortage of capacity nor anything that he would describe as a hard market.

“Pricing will continue to tighten; but a hard market? No, we’re a long way from that.
“Rates will continue to improve but there is still plenty of capacity out there and far too much cover within property reinsurance contracts. Investors are just being more discerning in what they want exposure to,” he said.

Portfolio changes
In line with this sentiment, ILS Capital Management has made adjustments to its own fund. Clinton said it has reduced its exposure to Florida cat risk by around a third, to less than 10 percent of its portfolio.

“The Florida market is broken from a moral hazard perspective,” he said.

“Direct Floridian insurers face a serious challenge to win back the hearts and minds of their insureds who are continuously bombarded by ads from law firms saying ‘do not go directly to your insurer, we’ll get you far more money’.

“Consider what the market just dodged in Hurricane Dorian. AIR says that Hurricane Andrew today would be $127 billion.

“Had Dorian stalled 80 miles further west, you would have been looking at Armageddon in terms of losses.”

Outside Florida, around 25 percent of ILS Capital Management’s exposure is now in the US primary insurance market, thanks to its investment in US auto insurer Producers National Corporation; 33 percent of its capital is in the marine and energy space globally; the rest is exposed to a variety of other property-cat risks globally, including in Japan.

“We are very pleased by the performance of our investment in the US insurance space. Rates are improving, new technology is helping to reduce costs and we are expanding into new markets and classes.

“This diversification provides balance and will mean more stable results over time,” he said.

ILS Capital has also been working on its own solutions to avoid trapped capital. On its marine and energy contracts, it has started inserting a clause that means the cedant pays an additional premium of between 10 and 25 percent in the event that capital is required to be kept in the structure because of uncertainty over losses.

“It is a logical tool and we have had some success with it in the marine and energy space,” Clinton said.

“It is harder in the property cat space because it is a much larger market with more players, but we think it could be applied there as well.

“If clients are faced with a penalty for trapping, they may think twice about it. The key, however, is that you must keep some dry powder to be able to top up prior years’ accounts if the losses develop.

“In that sense, we operate like a traditional player. In the marine and energy market, we have worked with these clients for years and there is a level of trust. We run our company more like a balance sheet reinsurer than a fund.

“The utmost good faith we have with our clients is a highly valued asset,” he concluded.