ILS casualty drumbeat gets louder
One problem with writing a monthly newsletter is that the "news" simply doesn't stop as one is actually writing the piece. One after another, alerts, bulletins, and new stories keep popping up with each one potentially affecting what we're writing in the monthly CATEX Reports.
Eventually though one does have to just stop and recognize that if we "sat" on a monthly edition waiting for the news to stop we'd never be able to complete one because the news won't stop.
Here's what stymied us a bit this month and we actually missed it at first. We saw this article in Artemis saying Willis believed because of the increased ILS competition in property CAT reinsurance (and the resulting plummeting premium prices) that reinsurers would soon choose to deploy their capital in casualty reinsurance products which could lead to a softening of casualty reinsurance premiums as a result of stiffer competition.
At first this seemed an observation you frequently see and one not particularly earthshaking. In fact our first thought was that it really proved that all those mono-line property CAT reinsurers had all effectively branched out into full product reinsurers if Willis believed they would switch capital emphasis from property CAT to casualty.
Then we looked more closely at the story and in the 6th paragraph saw what we thought to be really big news. Willis Re said that Watford Re, the casualty focused sidecar backed by Arch Re, demonstrates the growing willingness of capital markets to support casualty capacity.
The article quoted Andrew Newman, Willis Re's head of specialty casualty, saying that Watford Re, launched in January 2014, "confirms that new capital, in search of non-correlating returns is willing and able to enter the casualty market and participate at risk level, just as it has in the property catastrophe market."
This is big news no matter how you slice it. One could forgive Newman, who we do not know, the head of casualty for one of the Big Three, if he was optimistically straining to see signs of an ILS-fuelled capacity wave that had benefitted his property CAT colleagues finally reaching the shores of his own sector.
However, taken in context with the other news of the month, we don't think Newman was "optimistically straining to see" anything. He may have been calling it like it is.
Here's what we mean and there were several tell-tale signs with the most obvious one being the news that the RMS-backed Praedicat launched the first casualty liability model which provides analytics for casualty risks to the financial services industry.
Hemant Shah, the RMS CEO and director of Praedicat framed the news this way: "Property insurance has been transformed by catastrophe risk modeling. The Praedicat model (CoMeta) represents a real breakthrough for the industry and the beginning of an exciting time for commercial casualty and related capital markets."
Now, Hemant Shah doesn't get to be the CEO of RMS without being able to be very good at reading tea leaves. (It does help that he is a co-founder of RMS). But as we've been saying for several months now it is only a matter of time until the ILS market looks very carefully at casualty reinsurance as an underwriting opportunity.
We've asked this question directly to two of the largest ILS fund managers --why not casualty --and the response includes two components. First, they answer that the casualty models are too complicated and by definition not predictive enough for capital market investors. Secondly, they note that capital investors would not stand for the inherently long tail associated with casualty cover.
Sometimes a third reason is thrown in, too, and that's the observation that there is still "plenty" of capacity remaining in both the property CAT market and the property market itself for ILS investors without needing to enter the more risky casualty arena.
It's hard to argue with guys who have had success --phenomenal success at that! But two things may be changing this and if models like Praedicat get any traction you can add them in as a third factor.
Property CAT premium rates have plummeted and people have short memories. Read this article about a Florida lawmaker decrying as "simply insane" the Florida CAT Fund's proposal to buy up to $1.5 billion of traditional property CAT reinsurance.
Apparently even though Florida is sitting on 30% of the entire US coastal property value of $10 trillion, and is the state most prone to hurricanes, some people think the decreased premium rate party will go on forever.
But low premiums are low premiums and affect returns whether paid to a traditional reinsurer or to an ILS vehicle. This means that underwriters at some point will cry "uncle" and stop writing. Whether this restraint would extend to ILS companies was unknown. But the ILS underwriters, you will recall them as being described in this very space as so called "plug and play" underwriters, apparently have a bit more backbone than thought.
XL Group CEO Michael McGavick was asked during an earnings call earlier this month how he would react to a continued influx of ILS capital, creating continued downward rate pressure, until rates became inadequate for traditional reinsurers.
McGavick said that what he'd seen at the 1/1 renewals had made him feel comfortable. He mentioned that the "frenzy" going on in the market "wasn't so much what the alternative capital guys were pricing at --it was the frenzy among the existing players not to lose share in reaction."
He elaborated saying "They (ILS underwriters) were more disciplined then I think some are thinking. Some are thinking that the alternative guys just came in and whacked the market. No, what happened was the traditional players were so focused on keeping those shares that they got engaged in their own little frenzy."
Summing up he said "I don't feel the alternative guys, and I certainly don't expect our alternative guys, are going to be somehow irrational. I think they have a different set of costs. They have different appetites and they'll play that card."
Discipline? From ILS underwriters? Who'd have thunk it? Think though about this --and this is our second point related to ILS entry into casualty -- if what we read is true, and pension funds are beginning to invest in ILS funds for the non-correlated safety of event-driven risk, what does that mean?
The first thing it means is that pension fund managers are serious when they say they're looking for risk not correlated to the stock, bond, commodity, real estate or currency markets. (Admittedly, an incomplete list!) If you are a pension fund manager you already have more than enough of that risk.
A pension fund manager who has an investment in uncorrelated risk can be relatively sure it's walled off from the vicissitudes of the economy and is dependent only upon the occurrence of a described risk event which to date has been pretty much relegated to a CAT event.
Here's the leap that, per Willis, people like Watford Re have made though. Of course the potential of a hurricane or earthquake event is uncorrelated to general economic conditions but how big a leap is it then to extend that non-correlation to liability causing events such as malpractice, workers comp, and professional liability?
Remember that for the pension fund manager perhaps the first goal is to preserve the asset by walling it off from any effects of market disruption. If the asset can make a nice return over time then so much the better. And it there's one thing pension managers understand it's the management of time. Everything they do is done with an eye toward the future projected payments of benefits. They can determine with actuarial accuracy how much they will need at any given date 10 or 20 or 25 years ahead.
Given the sophistication of the commutation market these days there is little doubt that brokers, like Willis Re's Newman, are hard at work structuring deals that; make use of the non-correlative appetite of pension funds; the already longer tail view they possess in comparison to most investors; and some sort of date-certain commutation backstop after which they can draw a line under the investment for good.
Just as even two or three years ago people couldn't have predicted the effect ILS have had in the property CAT market it's quite possible that in the very near future we will look back and see that 2014 was the ramp-up to large scale ILS participation in casualty reinsurance.