As we now enter the final stages of the UK general election campaign, it seems that it was a political age ago that in mid-March the Chancellor, George Osborne, delivered his final budget of the current government. It was in that Budget report that Osborne noted that the insurance linked securities (ILS) market represents an important growth opportunity for the UK and that the government would work with the industry and regulators to develop a new competitive corporate and tax structure for allowing ILS to be domiciled in the UK and thereby making greater use of so-called alternative capital.
This announcement was widely welcomed, not least because it signalled that the government was listening to the market. Indeed, embracing the rise of alternative capital was one of the things mentioned by the London Market Group (LMG) to government, the LMG being the body set up to create and articulate a vision for the London insurance market and to identify areas in which proactive action may be taken to improve London’s competitive position.
A number of issues are, however, raised by this announcement, including what the consequence would be should there be a new government (be it a majority, minority or coalition government) after the general election on 7 May. Will the new government be as committed to delivering on this? Time will, of course, tell on this.
Leaving this aside, another issue to consider is what are the barriers to be overcome in order to establish the UK as a leading ILS centre and how manageable that will be. Key barriers are likely to include the following:
- The speed and ease with which the insurance special purpose vehicle (ISPV), which will form part of the ILS arrangement (in the form of, for example, a “side-car” or the issuer of cat bonds or some other security), can be set up and the regulatory impact under Solvency II (which will be applicable in the UK from 1 January 2016) of such ISPVs on ceding companies (ie the extent to which ceding companies can recognise arrangements with, and investments in, ILS vehicles in, for example, determining their own capital requirements)
- Making the tax regime more attractive for ILS investors – some may downplay this issue, but it is likely to be a key factor for potential ILS investors – what the government’s appetite may be for this, set against a background of continuing austerity and spending cuts, will have to be seen
- Developing the right expertise, know-how and transaction documentation – this barrier should be the most easy to overcome as the expertise around the components parts of an ILS transaction already exists in the market
The UK regulators, in particular the PRA, are likely to have a number of concerns which they will want to see addressed. These will include ensuring the following:
- That the collateral which typically backs the ILS arrangements is sufficient and will respond in the circumstances envisaged
- That the ILS capital market investors understand the underlying risks which they are taking on and that they have sufficient know-how, including access to modelling capability, to properly assess these risks
- That the ceding company appreciates the extent to which risk is actually being transferred by it pursuant to the ILS arrangement
- The wider impact on traditional re/insurers as a result of participating in an ILS arrangement (such as with regard to concentration of risk, impact on returns on capital, and possible changes in business model etc)
Challenges… and opportunities
To deliver on this announcement, the political will and vision will need to be there. It is quite interesting to note that Gibraltar has just announced its first ILS transaction only 12 months after first announcing its intention to get involved in the ILS space.
In addition, the regulatory processes will need to be sufficiently streamlined so as to expedite the time in which an ILS arrangement can be launched. To an extent, the UK’s hands in this respect will be somewhat constrained by the Solvency II rules.
However, ILS also presents an opportunity – indeed, potentially a significant opportunity. As we have reported previously, there is an increasing recognition that alternative capital is here to stay. To not work with it would be to potentially miss out in a big way. The real prize is not so much ensuring that an ILS vehicle is domiciled in the UK but that there is an active ILS market in the UK and that ILS deals are transacted in the UK. This will provide easier access to the capital markets for European based re/insurers, and it will allow them to operate within a jurisdiction with tried and tested and robust legal and regulatory regimes, and which has a very deep talent pool of expertise.