Q1: HOW WOULD YOU CHARACTERISE THE HEALTH OF THE ILS MARKETS IN BERMUDA?
Craig Redcliffe: After a period of no growth over the previous few years, largely due to some heavy losses in 2017 and 2018, 2021 saw a return to growth. It’s through a mix of growth at some of the larger existing insurance-linked securities (ILS) managers, the formation of new managers and the launch of new funds.
We’ve seen some significant new ILS bonds, as well. Overall, 2021 has been a period of renewed growth in the ILS market, which is encouraging.
John Huff: 2021 has been a challenging year, and we’re only in the fourth quarter. Some of the losses have been significant. Consider the three headline losses: Winter Storm Uri in Texas, Hurricane Ida and the European floods.
As a result, the ILS markets are under pressure. I heard a CEO say last week that some ILS investors are getting a bit tired. As we approach the 2022 renewals, it will be an area to watch. Some are predicting a very late renewal.
Greg Wojciechowski: Despite the macro challenges confronting the market broader market, we see many positives on the cat bond side of the market. In 2020, issuance totalled around $16.4 billion and 2021 is poised to be a record year for issuance on the Bermuda Stock Exchange (BSX).
The first half of the year was robust and the total number of ILS listed issuers is now at a record level for us. It is also interesting that we have seen more ILS deals incorporated outside Bermuda, as seen by the recent Chinese deal done out of Hong Kong. But many, including that one, are listed on the BSX.
I believe that this is testimony to Bermuda’s tried and tested ILS platform. While new sectors and new areas of support for ILS are emerging, Bermuda has stood the test of time. It has maintained its position as a global centre of excellence for creating, supporting and listing ILS vehicles.
Brad Adderley: It’s been interesting last year; a mixture of good and bad. There is more competition in the market, and we see seeing sponsors who previously used Bermuda potentially using other jurisdictions.
We see a lot of newer jurisdictions. Singapore has accomplished a lot more. More jurisdictions mean more competition, which is a good thing, but it also means more transactions and that‘s positive, especially if they come back to be listed in BSX.
Another positive is that we have seen some fascinating new ILS funds launched, some with substantial capital. We are seeing some funds with close to $1 billion, which is quite impressive. They are doing that within 18 months.
So money is coming in. I think the next phase, and you’ll definitely see Bermuda being the market leader on this, will be around new types of risk being transferred through the new classifications of vehicles.
I believe the sentiment and the mood around ILS is that we’re doing exceptionally well in growing the industry and bringing new items to the marketplace.
Justin Hull: Money has come in but there is also some risk aversion. The new money that has flowed in has primarily gone into the 144A market, rather than middle layer reinsurance. In turn, that has caused spreads to tighten.
Conversely, on the traditional reinsurance side, prices are hardening dramatically due to the losses in 2021. It is a bit counterintuitive that we’d see spreads tighten in the 144A market and the traditional reinsurance rates widen out, but that is what is happening.
Niall Baird: There’s clearly a preference for higher layer, lower volatility stuff that has also been delivering returns. We have to acknowledge there have been some significant losses for investors in the past four years and there is fatigue. That said, all things being equal, returns should look more attractive in 2022 than they have for a long time.
There’s also been a move towards creating more joined-up vehicles, where deals also leverage carriers’ rated paper.
That was triggered by the problem of trapped capital, but it can mean lower costs and ultimately higher returns to better leverage structures. I can’t see that any of these trends are going to shift any time soon.
Q2: WHAT IS THE SENTIMENT OF INVESTORS AND ISSUERS?
Baird: There is some caution among investors, despite common sense telling them that now is an excellent time to get involved. There is a concern about the models in the context of climate change. There’s a lot of appetite to see more modelling, more data, newer models and maybe some acknowledgement that the existing ones haven‘t been working that well.
That reticence is driving people into the lower volatility, safer, higher layers space. We’ve seen a significant shift there.
There is growing interest in different pools of risk, maybe specialty risk. Some of the funds might start accessing things such as cyber and crypto risk. Issuers’ interest in third party capital is as intense as it’s ever been.
It is often seen as part of a parcel of opportunities for carriers to diversify their capital base by using traditional structures from ILS to quota share to sidecars, to run-off.
It is part and parcel of the holistic view around how the more advanced carriers are beginning to develop.
Redcliffe: I agree that the non-modelled losses continue to be an issue from an investor’s perspective. There’s a gap between what’s being promised, and investors’ expectations. That gap needs to be bridged. Investors have spent a lot of time talking to mangers about their models and how they should react in different loss scenarios.
Adderley: From a new formation point, we are seeing some interesting newcomers. There are plenty of investors still willing to invest and we have seen some funds raise a substantial amount of capital in a brief period.
Yet, I agree, there are a lot of losses. That dynamic is intriguing. But the new formations are experienced players—players who have already built a reputation in the market and are now venturing out to start their fund.
They are raising a lot quickly, but they have existing reputations. But it is interesting when you consider the recent losses, the concerns over climate change, the problem of trapped capital. If investors are tired, why are we seeing more money coming in? The marketplace is still growing. It doesn’t quite fit together. Maybe I only see the births and not the divorces.
But we’re continuing to see some losses diverging from their models. This continues to drain the patience of investors and could lead to a flight to quality. You could see investors focus on ILS managers who deliver on their promises, deliver on their performance, minimise the adverse loss development, and have a good understanding of how climate change impacts the models—and how they’re factoring in this risk into their pricing.
Much of this comes down to tactical one-on-one discussions and getting investors comfortable during their due diligence.
Hull: I am slightly less positive; the overall sentiment is loss fatigue. Part of the startups that we saw in 2021 was a function of timing: there were losses in early years and the money arrived then. It’ll be fascinating to see if significant amounts of capital come in following the events we had in 2021.
Rates are going up and historically that has been enough to get investors excited and make allocations. But investors also increasingly realise that higher rates are meaningless without the proper quantification of risk.
Investors are saying, “OK, 15 percent rate increases are exciting, but I have no frame of reference for what that means, because the risk may have been understated by 30 percent.” On a risk-adjusted basis, they are not clear that is a good trade.
I do agree that the new money will go to quality managers: those who can demonstrate they can adequately quantify risks, who have included climate change in their modelling, and can show investors that.
Wojciechowski: If you look at this from a historical perspective, this is still a maturing asset class. When ILS first started to gain traction with institutional investors, the main reason was its robust yields and low correlation to the broader capital markets.
You might now ask whether macro-environmental circumstances have changed this dynamic, considering the pressure on the interest rate environment. As better yields are available elsewhere that might test the appetite of investors.
But the ILS structures being used have matured over the past 10 years. They have proven to be an effective way for the capital markets to gain access to risks unavailable before.
We’re watching the asset class mature. We’re seeing more diversification. Risks such as cyber and flood are being looked at which is an intriguing development. Perhaps risks such as terrorism, mortgage risk and future catastrophic issues such as oil spills can be covered. What is clear is that this asset class has the attention of institutional investors which can address the protection gap that continues to develop globally. The insurance industry and the capital markets can work together to help close the protection gap.
I remain optimistic. The ILS vehicle is now a palatable instrument for capital market participants who are willing to look at new opportunities that exist in risk transfer.
There are going to be tests and shocks, but history has shown this asset class is robust. It continues to be an innovative solution to allow ongoing access to insurance risk.
Huff: I agree on the flight to quality taking place as investors make that differentiation. Perhaps the traditional reinsurers that also serve as ILS managers may have an edge here because they‘re putting their own balance sheet at risk for the same risks.
There are some complex factors at work. You have the losses, the challenges of modelling climate change, and the overlay of inflation, whether it be economic inflation or social inflation.
We are at a pivotal time where there will also be an increased cost of capital in the ILS space. There will be a flight to quality. Investors will go to folks that have a better understanding of the risks. It will be interesting to see who ups their game around modelling climate change.
Q3: WHAT NEW DEVELOPMENTS DO YOU SEE IN THE ILS SPACE? HOW DOES ESG FIT IN?
Baird: Environmental, social, and corporate governance (ESG) factors are talked about a lot. The insurance industry is a sharp end to climate change, but it is also debateable how ESG-friendly ILS and reinsurance can be.
Yes, you cover the ‘environmental’ element of ESG but in terms of governance and social, it’s tough, if not impossible, to have any real insight into the ‘S’ or the ‘G’ of the underlying insured.
The more appropriate place for the industry to start creating ESG-friendly products might be in insurance rather than reinsurance or ILS. When we help rebuild things after an event, our ‘S’ credentials are good. We should start thinking about the ‘S’ and the ‘G’ a bit more. That would be a healthy thing for innovation.
Redcliffe: There’s certainly an opportunity in the ESG space, especially in the public markets. It’s been a huge focus, partially given the US Securities and Exchange Commission (SEC) mandating certain disclosure requirements. As there is more focus from a regulatory perspective, there’s an opportunity for the ILS market to do more. It’s right that the risk financing, recovery and repair after severe weather events are favourable from an ESG perspective, but there are other components of ESG that need to be focused on as well.
We have received inquiries from specific ILS funds, to potentially launch ESG-relevant products. We‘ve seen a little more of that in Europe, as opposed to Bermuda but that is something that is starting to gain traction. There is an opportunity but also a risk of being left behind. We’ve already seen several European funds launch ESG funds, and we need to play a bit of catch-up.
In terms of wider innovation, there has been more interest in different perils. Speciality risks are being looked at and new regions. There is an appetite for that. There is a need for that, whether in Asia-Pacific or Latin America. The problem is the modelling of those risks: you need the relevant data and the relevant models to make sure that the risks that you‘re putting into your funds are properly modelled.
You do not want adverse surprises, which has caused some of the issues with investors. So, as an industry, we must tread carefully into some of these new perils and new regions to make sure that we have the data to support the underlying risk.
Huff: We’re seeing quite a bit of interest on the US regulatory side on ESG. And that might tie in with some of the work that the Bermuda Business Development Agency (BDA) has been doing around climate risk finance—pushing Bermuda to leverage its competitive advantage on natural catastrophe risk transfer in the climate risk finance space. It is very much in the zone of what we’re good at. We have this long and rich history of natural catastrophe expertise and risk transfer capacity.
We have the talent on the Island, whether it be in modelling, pricing, or analysis related to climate risks. And of course, we have the world-recognised Bermuda Monetary Authority (BMA), which will be increasingly important. In some jurisdictions, like the US, you have federal regulators—the alphabet soup of agencies—with overlapping mandates. One strength of Bermuda is that we have one consolidated regulator that can look at all aspects of an issue.
Hull: We saw a pretty neat transaction in 2021 when Generali did a cat bond that freed up capital to invest in green projects. I’ve seen many examples of greenwashing with ESG, but I thought it was a great example. Investors accepted a lower spread on the bond because it was considered ESG-compliant. As a result, this is an opportunity for sponsors to be ESG-compliant and issue at tighter spreads than they would otherwise.
Adderley: There could be some other innovations coming up. We could see the first ILS vehicles using a cryptocurrency. The BMA is looking at these new innovative classes as they come up. There are a lot of new insurtech companies being formed which could also drive things. This will be a hot topic, and by year’s end, you might see a new vehicle like that.
Wojciechowski: ESG aspects are starting to attract the attention of a whole new demographic of investors. The overlying point here is that ESG is a massively broad notion, and no-one yet has a firm definition of what ESG entails in terms of compliance. The SEC is looking at disclosure and transparency around ESG, as are the EU securities commissions.
This is an emerging area; the vital consideration is that ESG is on the front of the minds of investors, board members and chairs. It is a topic that’s not going away, and Bermuda is very well positioned to take advantage of it. The BDA is creating a climate finance programme, which is an exciting move with the potential to have a global impact.
ESG is very much part of what we’re going to be hearing for decades to come at the BSX and we’ve been very aware of ESG through our affiliation with The World Federation of Exchanges. We’ve been discussing the value chain, and we’re in the process of setting out standards. We want listed companies to have some guidance that will dovetail with jurisdictional regulators as they approach disclosure and investor protection.
It is moving in the right direction. If we look at the UN’s Sustainable Development Goals, one is to make cities and human settlements inclusive, safe, resilient, and sustainable. Yes, it’s a broad, feel-good statement, but ILS possesses the characteristics necessary to foster resilience and assist communities in rebuilding following catastrophic types of dislocation and pressure.
This is very much why ESG is going to be a very necessary and popular topic. What’s notable is that investors are voting with their dollars which impacts what companies are doing. People are starting to put their investable dollars behind that and there is a shift around new wealth creation among socially aware millennials. They want to raise this as a topic to discuss and embrace.
Bermuda is well-positioned partly because we live on an island. Climate change will adversely affect us if it really accelerates in a catastrophic way. But we have a history of monitoring the climate and protecting the environment here. Conservation is in the Bermudian DNA.
This discussion about climate finance is particularly relevant given the depth of experience in the Bermuda-based insurance industry—climate risk has been an area of expertise for the last 30 years.
Q4: WHY DOES BERMUDA REMAIN THE WORLD LEADER IN ILS? ARE THERE ANY THREATS TO THAT STATUS?
Wojciechowski: First and foremost is Bermuda’s geographic location. We’re placed comfortably between two of the deepest capital markets in the world and two of the largest insurance markets in the world. We also have an independent regulator that is very aware of the nuances of the business.
Second, we have the talent and experience in providing the market with bespoke insurance solutions. Our companies and clients are global so Bermuda has developed the bench to provide that experience to drive innovation. Whatever the next market shift or innovation, we are well positioned to adjust—not to mention the world-class stock exchange we have.
I like to say we are the Silicon Valley for ILS. A decade ago a lot of experienced people spent time making sure that this nascent product was well created and suited to the type of work we do here, whether it was from a regulatory perspective, an exchange perspective, or with our service providers.
Bermuda, for our clients, is tried and tested. Clients appreciate the bespoke support they get in a lot of ways. Some of our competitors are using incentive mechanisms to attract business, such as rebates for incorporation fees, but Bermuda hasn’t done that. We will continue to compete based on our experience and the support we’ve given our clients.
The BMA recently expedited the incorporation time frame for ILS vehicles to a couple of weeks but for me that is one of our competitive advantages—leveraging our knowledge and understanding of these products. We’re comfortable that we can flag something that doesn’t meet our requirements within that time frame.
We also want to help drive the market’s growth. We don’t necessarily want to consume more of the pie, we want to grow the pie.
Redcliffe: The idea of the Silicon Valley of ILS resonates. I would only add that there is a dual skillset needed in ILS. You need that asset management expertise, but you also need the insurance expertise, and not all jurisdictions have that capability.
Bermuda is uniquely positioned in that regard. That’s why you see a lot of ILS managers launch funds here—because Bermuda has that unique skillset.
The reporting aspect of interacting with investors, the communications with investors, in addition to all of the due diligence requirements—these are different skillsets that a traditional reinsurer typically has. These skillsets are more aligned with asset management. Bermuda is uniquely positioned when it comes to combining these two skillsets into one organisation. Bermuda is in a good spot, but there’s a lot of competition out there.
A lot of people are gunning for us, so it’s not a time to be complacent. We need to continue driving and pushing forward and creating innovations and outreach with prospective investors and onshore lawyers. All of this is very important.
Hull: We are very much focused on speed to market, and a three-day special purose insurer (SPI) registration is extremely valuable to us. We know the folks who are involved in this. I think there’s more talent in Bermuda with respect to SPIs than perhaps anywhere in the world. We’re confident that it can be done quickly and effectively.
Adderley: Bermuda is a melting pot. We’ve already heard about the new speed market and how the BMA is processing things more quickly. You also need less documentation than before. The documentation is more focused now. That will help us compete.
The innovation taking place is important too. I mentioned the tech side and cryptocurrency potential. Bermuda is a natural place to combine that with ILS. It’s the whole melting pot of what BMA is doing.
Other jurisdictions are trying to compete with us. But they’re trying to catch up to what we’re doing. The BMA is doing an excellent job of keeping one step ahead. Yes we might see more cat bonds in another jurisdiction but that helps grow the whole pie.
In the next year, you’re going to see even more innovative things coming out: different structures, different risks.
Q5: WHAT ARE YOUR PREDICTIONS FOR THE DEVELOPMENT OF ILS IN BERMUDA?
Huff: It’s just like the realtor who keeps saying “location, location, location”. The theme you’ve just heard is “talent, talent, talent”. It’s the talent in Bermuda that will push us and give Bermuda the edge whether that be on the regulatory side or in startups.
2021 is going to be a tough year for both ILS and the traditional side. Looking into renewals, the reinsurance retro side will likely drive the 2022 rate, which is a change from the past. You’re just seeing the additional cost of capital and the cost of volatility come through.
Wojciechowski: My hope for 2022 is that the momentum we’ve seen at the end of 2021 continues. As of September 30, we had 719 ILS vehicles representing about $50 billion of risk, or about 95 percent of what’s issued in the global market. I’m just delighted to be working at a company that’s supporting global ILS growth.
Also, being a capital markets platform operator, we’d love to see some secondary market trading, which is done on a “lite” market, not so much over the counter. If we can continue on this path, it’s not only good for Bermuda, it’s also good for growth.
I tip my hat to the people that started down this ILS path back in the mid-2000s, those who had the vision to push this as an innovative solution for Bermuda. If we continue to focus on innovation, what clients want and providing solid platforms in a well-structured regulatory framework, we will succeed. We are well positioned to continue to innovate and provide solutions in the future.
Hull: The retro market will be dislocated, or at least very distressed, on January 1. That will cause traditional reinsurers to seek capacity elsewhere, as they did in 2019 and 2020. So you could see many more aggregate property-cat bonds going into the 144A market.
On that note, the capital markets will continue to grow their appetite. I could see it starting to compete more with traditional players, particularly for middle layers. In the past 10 years, we’ve seen the expected loss go from 2 to 3 percent, indicating that things are getting riskier. I could see that trend continuing as well.
Last, at the end of 2021 and 2022, climate change risk quantification will take hold. Every fund that wants to win new mandates will be required to quantify climate change risk in its models.
Adderley: We will see a lot more new risks being written in the ILS space and potentially also with different currencies. We could see non-cash crypto coming to this space, especially as a space where people struggle to buy policies right now. Next year we might see one or two vehicles that are trying to solve this problem.
Redcliffe: I believe that we’ll see new risks continuing to come into the market. We already see some casualty and speciality in the ILS market, but that’s going to expand and we’re going to see growth. But there are some difficulties we need to overcome. Aggregate covers are a particularly tough product for ILS, producing problems for investors. You’re getting a lot of unexplained variances from models.