In the aggregate, heading into 2020, investor appetite for the insurance-linked securities (ILS) sector remains strong and the thesis for long-term strategic allocation to this diversifying asset class continues to be intact, according to Shiv Kumar, CEO of MMC Securities.
However, investors are exhibiting a strong preference for more liquid strategies. Consequently, catastrophe bond portfolios are generally sustaining net inflows while there is reduced appetite for collateralized quota shares. This compression of available capacity away from the 144A market undoubtedly presents interesting opportunities as rates, terms and conditions are adjusting to the benefit of investors. The tightening of structural terms combined with risk spread expansion across all products is making the case of insurance risk investment as strong as it has been in the last 10 plus years. The most critical aspect of capital markets capacity in the current environment is its persistency. While there may be some rotation in product specific preferences, we believe significant capacity will remain available from the capital markets through various cycles going forward.
There has been limited penetration of alternative capital in Lloyd’s to date. The new leadership there is very focused on this aspect. Following extensive market consultation with ILS investors, Lloyd’s will embark on the first phase of its new Future at Lloyd’s blueprint in 2020 which will include a focus on making its “Funds at Lloyd’s” capital processes more transparent and efficient by allowing capital to flow in and out of the market easily. We are very supportive of this ambition and will continue to play a constructive role in assisting Lloyd’s in the development of its initiatives.
We have seen diverging fortunes over the last 18 months for capital light versus capital intensive businesses. The dominant M&A theme in the broker / MGA market has been strong transaction multiples, regularly exceeding 15 times earnings before interest, tax, depreciation and amortization, fueled by a potent combination of private equity flush with liquidity, acquisition hungry consolidators and a relative lack of supply of scaled operations.
Conversely, a number of transaction processes for insurance carriers have struggled to take off, particularly for poorer performing assets. This has been more noticeable in the Lloyd’s market where several failed processes have resulted in some noteworthy businesses being placed into run-off. That being said, strong businesses will always command respectable valuations as indicated by the acquisition of PURE by Tokio Marine.
Insurtech companies face a major challenge of acquisition/retention of policyholders while operating as a capital-lite platform. As they do not have established brand names, they must aggressively market to acquire customers which leads to high acquisition costs. These upfront costs cannot be capitalized and result in a reduction in surplus. Reinsurance is usually a highly cost effective means to transfer this type of risk and optimize the level of capital required at the carrier level but it lacks the funding component. We have been developing unique structures which combine surplus relief and funding to allow for competitive alternative capital participation.
There has been much speculation about cyber risk transfer in the alternative capital space and a couple of small transactions have been completed to date. However, cyber risk presents unique quantification and packaging challenges for ILS structures because of its complex and evolving nature. We find investors to be open to cyber risk education and having a point of view on pricing, but they are reluctant to put up meaningful capital on a standalone basis against cyber risk at this stage. They have only recently begun to accept cyber risk as either one small component in multi-peril portfolios or in leveraged structures where the same collateral is supporting several independent risks of which cyber is one. This is certainly a positive trend.
Going forward, we expect that the evolution of cyber risk transfer in alternative capital space will be intermediated through rated balance sheets. In other words, a typical structure will likely require a rated (re)insurer to underwrite a portfolio and then transfer a defined/ aligned slice of risk to capital markets investors at acceptable economics and commutation provisions. As such, early transactions may look more like typical private sidecars than tradeable 144a cat bonds. All market participants clearly understand the vast potential of this emerging risk class and the need for structures which are palatable to the various stakeholders. Over time, as cyber risk becomes better understood and more tractable, we look to promote a robust alternative risk transfer market in view of the evident supply-demand imbalance.