Captive Review (CR): The ILS market has seen significant growth in the last year, why do you think that is?
Gavin Parker (GP): It is a symptom of difficult market conditions that investors look around for new types of investment, needing to work harder to get a return on their assets. In the current economic climate we are seeing investors considering putting their money into alternative products, structures and services and also being more realistic about the returns that are possible and available.
Insurance-linked securities (ILS) is one such area. With the insurance industry continuing to write more diversified lines of business, such as cyber terrorism and hijack, the industry is continuing to seek more efficient ways of accessing capital. At the same time, investors are looking for better returns and diversification in asset classes which are uncorrelated to financial markets; ILS offers a mutually beneficial opportunity. In terms of return generation this method of asset management is making a comeback with significant amounts of business starting to take place, particularly in offshore jurisdictions like Guernsey. To an investor ILS contracts are attractive as they are unlinked to financial markets and so offer a means of exposure to reasonable returns in an alternative, non-market linked, asset class. The investments and the yields available with ILS are drawing in cash-rich investors, typically institutional investors, who previously wouldn’t have invested in the insurance industry.
CR: Why is a securitised trust required in ILS structures?
GP: In a typical ILS transaction a special purpose vehicle (SPV) is established, which has two functions: to issue securities to the investors and to provide reinsurance for the insurer. The SPV will typically collect the investors’ cash and deposit this into a trust, the investors become the settlers of the trust and the insurer becomes the beneficiary of the trust. Throughout the life cycle of the ILS, if there is a catastrophic event the SPV will meet the costs of this event and the requirements of the insurer. If there is no catastrophic event the investors receive back their collateral and any interest payments due to them under the structure.
The securitising of the trust vehicle in this transaction provides comfort to both the investors and the insurer that their interests in the common pool of assets are both represented and controlled independently by a third party, often a trustee. In this scenario the trustee will administer the common pool of assets against pre-defined parameters and rules set in agreement of the investors and the insurer. Any distribution of the pool of assets will meet the rules and objectives of this agreement and ultimately the objectives of the ILS structure.
However, it is not always the case that a trust vehicle is the only required security vehicle for ILS (although the US cat bond market has made it common place) and at Barclays we are currently developing a security interest agreement (SIA) as an alternative offering to our security trust agreement (STA). These structures will achieve the same objective and deliver the investor’s and insurer’s desired outcomes; the difference will be that the SIA will work without trustee oversight.
CR: How big do you feel the ILS market will grow?
GP: The cat bond market in the US is very mature but still continues to see growth. The European equivalent, the ILS market, is less mature and is certainly gaining momentum. Focusing on Guernsey, there is high interest in the ILS market throughout the finance sector and while this continues, there is no reason to suggest that ILS will not feature in Guernsey as a major growth opportunity for the island. The scale of some of the transactions that are now being established and administered from Guernsey is great. Guernsey is executing these transactions profession- ally and with appropriate consideration to the risk frameworks and controls that need to be in place. This approach resonates throughout the insurance industry outside of the island and cements future growth for Guernsey.
A further consideration is the type of insurance that these products focus on which can be broadly summed up as losses caused by natural disasters and uncontrollable events. Most of us will have noticed, even locally, that weather patterns are changing and frequencies of ‘freak’ experiences are increasing: an example being the annual flooding in the UK of late. ILS structures are fed by these uncertainties, known as high severity low probability events, and while these changes continue, insurers will continue to seek to diversify their exposures meaning ILS will be a viable solution.
“To an investor these [ILS] contracts are attractive as they are not linked to financial markets and so offer a means of exposure to reasonable returns in an alternative, non-market linked asset class” GAVIN PARKER - BARCLAYS
CR: Is there any sign of investor fatigue in the ILS space?
GP: We do not see any fatigue, in fact to the contrary we are seeing a greater awareness and greater interest in ILS. To an investor these contracts are attractive as they are not linked to financial markets and so offer a means of exposure to reasonable returns in an alternative, non-market linked asset class. Cat bonds can be grouped by their level of risk and then sold as portfolios in securities markets (ILS) which allows investors to ‘club up’ and take a limited exposure to any one particular cat bond by investing in a portfolio with many other investors. The nature of the investments means the chance of losing funds is very low due to the low frequency of claims. However, due to the risk of a claim and the loss being severe, the returns can be greater and in a balanced investor’s strategy a non-financial markets linked asset is appealing.
Gavin Parker, of Barclays, discusses the ILS market in Guernsey and investor interest in the market