Captives and the ILS market: A third way

The insurance-linked securities (ILS) market is becoming a lot less “opaque”, but is still some way off becoming the go-to for captives, according to Risk Management Solutions director Stephen Moss.

In recent times, a number of destinations around the world have introduced regimes to cater to the ILS market.

Late in 2018, the United Kingdom introduced its ILS regime and has since facilitated two transactions. The first catastrophe bond was issued to Scor in June last year, which saw it sponsor $300m of Series 2019 Principal At-Risk Variable Rate Notes, Captive Review reported.

Earlier this year, Singapore introduced the first catastrophe bond under its regime, providing Insurance Australia Group with AUD$75M of annual aggregate catastrophe protection for three years.

Guernsey is the latest jurisdiction to get in on the act with the launch of a new hybrid ILS vehicle. In an announcement released at the time, Guernsey described the structure as a “protected or incorporated cell company that is both a licensed insurance company and a regulated investment fund”, meaning that ILS managers would no longer have to rent cells to act as special purpose insurers (SPI’s).

While it is well known that captives have not widely utilised the ILS market, a few high-profile transactions have taken place and the benefits are abound, claims Moss.

“Captive involvement in the ILS market is currently fairly limited,” says Moss. “There’s a couple of reasons for that: One of those is that the first time we saw a captive really utilise the ILS market was when the MTA used it after Hurricane Sandy in 2013.”

New York State’s Metropolitan Transportation Authority used its captive to gain $125m in protection from the ILS market after struggling to renew its reinsurance policies in the wake of the storm.

“There was another in 2003 – a Japanese franchisee of Disneyland wanted to protect revenues if there was a large earthquake around Tokyo. They pumped this through their captive and it wasn’t triggered, so everyone was happy.

“However, since 2013, we haven’t seen pricing conditions similar to what we saw back then,” he explains.

Despite few transactions over the years, captives are still engaged in the ILS market, but it has been at the larger end of the market.

“After the MTA, we have AMTrack, the national railroad company. We also saw some captives in California, which has a lot of west coast exposure, they jumped into the ILS market,” says Moss.

The lull in transactions could be down to the soft market conditions that the insurance world is currently experiencing, argues Mark Elliott, director of ILS at Aon.

When a captive has large exposure in a soft market, it is often cheap to acquire reinsurance protection in the traditional market, he explains. This means that there’s not enough premium to make it worthwhile for ILS investors.

“That’s the challenge in traditional programmes,” he says. “When you’re buying into the billions of limit there’s not much premium at the top end, so that’s the difference between a corporate risk and a Florida insurer where they have a very high peak peril risk – a hurricane for example. They’re prepared to pay a higher rate on line because their portfolio is exposed to that hurricane. That’s where you find a disconnection.”

The structuring of such transactions and an “administrative” burden can also steer captives away from the ILS market, says Moss.

Previous transactions have been in partnership with large reinsurers who can act as “faces of the market”, while captives are viewed differently.

He explains, “Historically we have seen providers hand out standard reinsurance contracts and push it straight out into the market, but they wanted to facilitate that process.

“We haven’t seen that huge push in the last three or four years because we’ve seen the downward trickling of the insurance and reinsurance markets, so there is undoubtedly a hurdle to engaging with the ILS space.”

Filling out securitisation documentation and putting the structures in place is also seen as a factor in why captives are not accessing the ILS market in droves.

“That hurdle has, to some extent, limited the number of individual captives that we have seen flow into the space,” Moss says. “The first time can be quite burdensome, but once you’ve done it, people tend to reissue, reissue, reissue.”

Despite having to tackle administrative and regulatory challenges, the ILS market can offer significant benefits for captives seeking reinsurance protection for their specific risks.

Whether it’s pricing, transparency or seamless nature of the market, knowledge of the market is slowly trickling down and captives are likely to utilise it more in the future, claims Moss.

“You can see where the insurance market is in terms of pricing, and then you can make a decision on whether or not there are inherent advantages of engaging with it.

“The transparency of this market might also help captives to maybe not take the full jump, but to engage a little bit more. For example, ChinaRe issued a small bond in 2015. It was so small it didn’t provide any protection, but they tested if it was something worth doing. It was very much dipping your toe in the water and trialling it.

“I get the impression that knowledge is starting to trickle down to them. It hasn’t been a flood, but I do think that things like the UK and Singapore adopting a regime improves people’s awareness of the ILS market as an option.”

Elliott claims that the market is “leaner” than the traditional insurance market, and risk managers are increasingly looking at their options to see if they can use their captive in a more efficient way.

“It’s logical that captives are and will look at ILS capacity – they’re the gateway to the ILS markets. I see captives being complementary to this in the future,” he concludes.

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