Articles - ILS - The beginning of an exciting journey

The London insurance market has traditionally been the home of complex and specialty risk underwriting and, as a global insurance centre, it is larger than its next three competitors combined. One innovation however that had passed it by was Insurance Linked Securities (ILS), which have been developed in offshore locations like Bermuda.

 By Malcolm Newman, Managing Director of SCOR’s EMEA Hub and Chairman of LMG's ILS Taskforce

 At their simplest ILS are collateralised reinsurance contracts where the investors subscribe for bonds to the value of the maximum exposure under the reinsurance contract with the cedant.

 Claims are determined by parametric triggers, for example the anticipated modelled loss of a hurricane hitting Miami at a certain wind speed, or the spread of an infectious disease using World Health Organisation data. ILS avoid the need for long and slow claims adjustment as payment can be made immediately after an event, giving the cedant the liquidity to handle its insureds’ claims.

 These bonds are issued by Special Purpose Vehicles (SPVs) often using a multi-cell arrangement, which holds each reinsurance contract in a separate cell with its own assets and liabilities ringfenced from the other cells.

 Until recently, the London market has been unable to compete for ILS business due to restrictions in the UK’s company law which did not recognise segregation of creditors within an entity, and there was no regulatory framework for multi-cell SPVs.

 The London Market response
 To address the London market’s inability to offer ILS, the London Market Group (LMG) wrote to George Osborne, the then Chancellor of the Exchequer, calling for action. He agreed to set up a joint taskforce involving experts from the insurance industry along with officials from the Treasury, PRA, FCA and HMRC. I had the honour of chairing this high-powered group, which over the course of nearly three years successfully navigated a general election, a change of chancellor and the Brexit referendum, to deliver the legal changes required to enable ILS to be created in London.

 It was clear from the first taskforce meeting that London needed to bring something new to the ILS market, simply providing another jurisdiction for collateralising property catastrophe risks would not succeed – we needed to innovate. We realised that if London is to become a leading market for ILS it needs to offer more than competitor markets.

 This is where the advantage of being the largest of the global hubs is a major asset. The London market has a reputation for developing new products, most recently the growing demand for cyber insurance has been met by products developed in London which now has a significant share of the global market. We need to combine our experience and technical know-how to become leading innovators in this burgeoning area of risk mitigation.

 The progress
 After many hours of work and hard negotiation in December 2017, the change in law and regulatory framework received cross party support in both the Houses of Commons and Lords.

 In addition to working with the Treasury, PRA, FCA and HMRC, the taskforce members also embarked on an education programme, speaking at conferences and holding lectures to raise awareness about ILS vehicles and the possibilities they offer to the London market. The lectures proved very popular and the questions and follow- up demonstrated that the intellectual power of the market was focusing on this topic. So, what will they come up with?

 Within two weeks of the new law being passed the first ILS authorisation was agreed, a sidecar vehicle to support the property portfolio of a Lloyd’s syndicate which went on risk from 1st January 2018.

 This vehicle falls into the category of property catastrophe risk that marked the beginning of the ILS market in the offshore locations, a standard and straightforward ILS instrument. However, it is a positive start and it’s anticipated that many other ILS vehicles will be developed during 2018.

 The opportunities
 From the beginning people wanted to know the scale of the ILS’ taskforce ambitions. Two common questions were: “What share of the market would London seek?” and: “What size would the London ILS market reach?” These were, in my opinion, the wrong questions – as they are the result of actions that are yet to be taken. The real question is: “What solutions can London develop?” - it is innovation that will determine the success and size of the London ILS market going forward.

 As the chairman of the taskforce I have the privileged position of having talked to potential market entrants, as well as the experts currently at work. What have I observed?

 Firstly: London is an attractive location to conduct the existing ILS business from. It has a strong stable environment, a well-respected regulator, the obvious support of the government, all alongside the intellectual and financial capital required to be successful.

 Secondly: The geographic connection of London gives it access to risks beyond the traditional ILS exposure of North America.

 Thirdly: The London market participates in all classes of (re)insurance both for life and non-life.

 Fourthly: The UK is not an offshore location. Some countries have tax authorities that may become involved if entities in their country wish to transact offshore, bringing additional cost and complexity which can make these products unattractive for cedants.

 So, as I gaze into my crystal ball what do I see as the future of ILS in London?

 I see exciting opportunities – as new geographic markets open up for ILS products; more classes of business using ILS vehicles alongside traditional reinsurance when executing their risk management strategies; and new demand for insurance from those who are currently under or even uninsured due to price or lack of capacity.

 What I am sure about is that London will be a major player in the global ILS market.

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