ILS needs a buoyant secondary market to thrive – but electronic platforms must come first

Adderley argues the primary obstacle blocking the development of a secondary market for ILS is habit.

“People need to get used to doing business electronically – not just in the secondary market,” he said. “Everybody accepts there is too much frictional cost lost in premiums, everybody knows the market needs to be more efficient. The answer to that is to use electronic platforms, but people are reluctant to be the first mover, they are waiting for others to move first.”

Adderley predicts that as more insurance business is conducted on electronic platforms, the pace of change will accelerate as electronification gathers momentum.

“The same thing happened with cat bonds registering as special purpose insurers,” said Adderley. “Once there is a greater acceptance of electronic platforms generally, we will see more interest in a secondary market for ILS.”

The proliferation of new insurance linked securities presents considerable challenges for regulators, noted Adderley. In particular, it raises questions about whether such products should be regulated as insurance or as securities.

“Cat bonds, sidecars and other structures linked to a collateralised vehicle offer insurance risk in security form,” said Adderley. “The answer is probably that it is a security, given that the insurance entities writing the risk are already regulated. The important thing is that investors have access to sufficient information about the collateral.”

Adderley warned of the risk of overregulation, which could prevent the market reaping the benefits of innovation as it tries to keep market participants safe, for example in the collection of ever-greater amounts of data related to know your customer (KYC) rules.

“The trend in regulation is to gather more information on things like KYC and credit checking,” said Adderley. “Twenty years ago KYC was something businesses should comply with but now it is absolutely crucial. A blockchain solution could really help here, allowing people to keep all their data in one place and giving institutions access to it when they need it.”

He added: “Regulation is important but too much of it encroaches on business’ ability to innovate and solve problems. That is why the BMA’s regulatory sandbox is so on-point, it encourages that kind of flexible approach to problem solving – which then benefits other insurers.”

But he accepted regulators have a difficult balance to achieve between allowing innovation and preventing market abuse. “With regulation there is a fine line between giving institutions the room to operate, and the reputational risk to a jurisdiction when something goes wrong,” said Adderley.