Key features of ILS funds in Bermuda
First published in Canadian Hedge Watch December 2017
Bermuda is a significant player in the reinsurance market and its position in this market has led to the growth of the use of funds as the funding vehicles for many reinsurance companies. The use of funds in this space is a result of the demand for such products by major institutional investors wishing to invest into the reinsurance sector but via a fund structure with which they were familiar. These funds may also invest in other forms of insurance-linked securities (ILS) including catastrophe bonds. The convergence of funds and reinsurance has led to a hybrid fund, namely ILS funds.
ILS Funds – What Are They?
ILS funds are basically funds that invest in ILS or, in other words, funds that invest in financial instruments and securities whose value are affected by insurance loss events including catastrophe bonds and shares in an underlying reinsurance company. As the value of these securities are linked to risks or events that are non-financial (such as natural disasters and mortality in the case of life insurance), these securities are considered to have little to no correlation to wider financial markets.
As mentioned, ILS funds often are the funding vehicles for Bermuda reinsurance companies which are typically special purpose insurers and Class 3 insurers licensed under the Insurance Act 1978, as amended. In addition, the underlying reinsurance companies are often registered as segregated account companies. ILS funds that would either subscribe for non-voting preference shares or funding notes in the reinsurance company which would be linked to a segregated account. The ILS fund would therefore indirectly participate in a portfolio of reinsurance and retrocessional contracts written by the segregated account of the reinsurer that often covers property catastrophe risk.
Main Legal Structures For ILS Funds
The most common structures for ILS funds include exempted companies limited by shares (including those companies that are also registered as segregated accounts companies) and exempted limited partnerships. ILS funds may also be formed as a unit trust. Unit trusts tend tobe popular with Japanese investors. In addition, Bermuda has recently introduced limited liability companies (LLCs) and this recent addition could also be utilised by ILS funds.