A Q&A with Brian Desmond, CSO and EVP Head of Fund Services at Horseshoe Group.
For readers unfamiliar with ILS Funds, can you give a brief summary of the asset class?
Insurance Linked Securities (ILS) are financial instruments sold to investors and whose value is affected by an insured loss event. Two examples of the financial instruments used are catastrophe bonds and collateralised reinsurance contracts.
The buyer of protection, or the entity that is transferring the insurance risk is called the cedent and the seller or writer of the protection could be an individual investor or a hedge fund. For investors in hedge funds, the ILS asset class is not correlated with financial markets, creating diversification benefits and an ability to enhance investment returns.
A hedge fund can buy or sell catastrophe bonds directly in the primary or secondary market. Cat Bonds involve the reinsurance of high severity, low probability events. The bonds are commonly structured as floating rate bonds with maturities of usually less than three years, so the investor would receive coupons periodically and, of course, has the risk of losing the invested principle if a significant loss event occurred.
A hedge fund can also invest in collateralised reinsurance contracts, which are private illiquid deals that usually have a 12-month term. To write reinsurance, the entity writing the business is required to have an insurance licence. Therefore, a hedge fund, for example, cannot enter into private reinsurance deals directly but instead will invest through a Special Purpose Insurer (SPI) or what is commonly called a Transformer.
The hedge fund will purchase preference shares of the Transformer and the Transformer will use the subscription monies received to write the reinsurance transactions.
Reinsurance transactions can take the form of a traditional reinsurance contract or derivative. The reinsurance limit or notional amount of the reinsurance contract is typically fully collateralised, thus removing any credit risk. The collateral assets are typically held in a trust account in highly rated liquid securities for the duration of the contract period until loss activity can be quantified. If the underlying contract is loss free, the collateral is returned to the investor along with the premium paid in by the reinsurance buyer.
In cases where investors or hedge funds do not have their own ‘transforming vehicle’, dedicated ILS service providers such as the Horseshoe Group can facilitate through the use of their own Transformer. Horseshoe can help investors interested in establishing an ILS Fund or accessing the ILS market in general, from the set-up phase through to the ongoing administration and valuation work, while also providing them with an infrastructure to invest into specific reinsurance structures.
Please provide a brief history of the ILS market
Back when Hurricanes Katrina, Rita and Wilma hit in 2005, the trail of devastation led to an estimated USD108 billion of property losses. At that time, reinsurance market rates skyrocketed and we saw a lot of reinsurance companies looking for additional capital. Hedge funds started to invest as expected returns for ILS structures were in the mid-teens. Since then, the composition of investors has evolved with the addition of large pension plans and family offices who have bought in to the low-correlation appeal of this asset class.
Since 2005, the market for insurance-linked securities has increased substantially, creating an industry with approximately USD80 to USD90 billion trading between capital market investors and the insurance industry. The performance returns, over time, have been impressive and help to explain continued investor interest.
In 2006, alternative capital was estimated to make up approximately 4 per cent of the total reinsurance sector. This is now estimated to be in excess of 15 per cent in 2017, so ILS capacity has become an increasingly more meaningful part of the reinsurance sector.
Please provide a brief commentary on Horseshoe’s positioning in the ILS market
As a pioneer in the Insurance Linked Securities administration space, Horseshoe has vast experience in all aspects of this unique and complex asset class.
Horseshoe can offer a true one-stop solution for those that want to set up a new ILS Platform, including the provision of fund administration, registered offices, corporate secretarial, insurance management, accounting, transforming, underwriting, claims and actuarial services within one company.
We are the foremost and largest dedicated independent ILS service provider team in the market with no affiliations with other service providers.
Horseshoe has a strong accounting backbone and a comprehensive set of skills including, corporate services, actuarial, underwriting and claims. On the ILS fund administration side, this wide range of insurance expertise allows us to provide an independent review of complex ILS valuations.
Launching an ILS Platform can be a daunting exercise but it does not need to be if one goes about the process in a methodical and organised fashion. At Horseshoe, our management team provides a consultative approach to all relationships no matter if we are introduced at the early platform formation stage or later on when an established investment management firm is contemplating the launch of a new product.
How did the ILS market react to the large losses in 2017 and what is your outlook for the ILS industry?
The Harvey, Irma and Maria (HIM) events in August and September of 2017 plus the wild fire events in December last year resulted in 2017 being the largest loss-causing year ever and was the biggest test for the ILS industry to date.
The good news is that the ILS industry passed this test, with investors showing their commitment to the space by increasing their overall capital investment in ILS to a greater level than before the large loss events of 2017.
New risk capital is coming to market as investors continue to find ILS an attractive and diversifying asset class. We are seeing investors look for new entries into the insurance and reinsurance business outside of primarily the property cat bond markets. This means new and innovative products and offerings in the life and annuity as well as the casualty space. In fact, in many respects those lines of business are at a stage now where the property focused ILS market was in 2005.
We predict some interesting growth in these areas and overall we believe ILS will continue to become a larger percentage of the overall reinsurance market and will reach the USD100 billion milestone before 2020.
The Horseshoe Group is an independent and privately-owned group of companies forming a leading financial services company dedicated to both the insurance linked securities and the alternative fund markets.
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