August 28, 2014

Converge or Die

André Perez, CEO of the Horseshoe Group, describes how capital markets are changing the traditional catastrophe reinsurance model.

Let us go back to when it all started. The year was 2005. Three massive hurricanes, Katrina, Rita and Wilma (aka KRW), hit the US and caused billions of dollars of insured losses. These three ‘evil sisters’ changed the course of how catastrophe reinsurance would be transacted in the future.

Of course, there were catastrophe bonds issued prior to 2005 and already some ILS funds in place when KRW hit, but in my opinion those three hurricanes were the tipping point for the ILS market.

Between the end of 2005 and mid-2007, a plethora of sidecars were formed. These fully collateralised vehicles essentially piggy-backed on the expertise of known reinsurers and gave an opportunity to fresh new capital (mostly hedge funds) to take on pure underwriting risk. During that period, close to $9 billion of new capital was raised through sidecars.

Aside from obviously capitalising on reinsurance rates which skyrocketed post-KRW, what else motivated these investors to come in droves? They discovered a class of assets with the unique characteristic that it had very low correlation with the rest of their investment portfolios, and therefore was providing diversification. Incidentally, this is still what motivates investors to make investments in ILS today.

Armed with this new knowledge, these investors also started to invest in ILS funds. This resulted in a proliferation of ILS fund managers which, aside from investing in catastrophe bonds, were also investing into collateralised reinsurance.

The picture of ILS was now complete and the three main pillars of this market—catastrophe bonds, sidecars and collateralised reinsurance—were well established.

From then on the growth of this market did not stop, save for the subprime crisis in 2008 which created a hiatus for a couple of years. The one big difference between 2005 and nowadays is the type of investors which are participating in this market, either via investment in ILS funds or through direct investments.

To read the full report on the Convergence market, click here to be re-directed to Intelligent Insurer.

Source: Intelligent Insurer


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