Insurance-linked securities ‘not a replacement’ for traditional reinsurance: NICC speaker

OTTAWA — Insurance-linked securities can help primary insurers get negotiating power with reinsurance carriers and Canada is a “nice fit” for these types of alternative sources of capital, suggested speakers at the National Insurance Conference of Canada (NICC).

“Canada would be a very nice fit in order to transfer more of this risk into the capital market,” said Michael Stahel, a partner with LGT Insurance-Linked Strategies at LGT Capital Management.

“Should you do all your reinsurance purchase directly with us? No. That is not the way to go. You should try to transfer some of your risk directly to the capital market. It will give you some leverage in your negotiations with your reinsurance (provider) because there is a second option.”

Stahel made his remarks during a panel discussion at NICC Monday in Ottawa.

Another panelist was Michael Brisebois, chief financial officer for TD Insurance’s life and general insurance business. Brisebois explained some of the advantages of ILS over traditional reinsurance.

“We can diversify the counter parties that we deal with, and have options as it relates to our reinsurance coverage, which obviously becomes particularly useful when there is a bad cat year, either domestically or internationally,” he said of catastrophe bonds.

By the end of June 2014, there was more than US$20 billion worth of catastrophe bonds outstanding, said James Lee, director of debt and solutions coverage for Deutsche Bank Securities Inc., at NICC. Citing data from Deutsche Bank and Bloomberg, Lee told NICC attendees that the issuance volume, of cat bonds alone, was US$5.9 billion during the first half of 2014.

“Barring any event, the amount outstanding will continue to increase,” Lee said.

“They are fully collateralized,” Stahel said of the money invested into cat bonds. “The money has been put into a pot. It sits there and if the event occurs it is being transferred to the issuer of the capital and there is no one who can hold that money back. I am not saying there cannot be any lawsuits around this because you have this in the reinsurance world as well. But the money has been transferred. “

Primary insurers still need to preserve their relationships with reinsurers, Brisebois emphasized.

“I personally don’t view this as replacement for traditional reinsurance,” he said of ILS. “It is something that supplements and complements traditional reinsurance.”

This is especially important for reinstatements, after an event that triggers cat bond coverage, Brisebois noted.

“A common feature of traditional reinsurance catastrophe programs is the ability to reinstate your coverage immediately after you have an event so that you are not naked on the risk,” he said. “On the cat bonds that I have seen … there is a question as to what reinstatement coverage you have with some of these. I know there are some examples of some reinstatement coverage being allowed but it does not work the same way as with traditional reinsurance.”

For investors in these bonds, catastrophe models are important, Stahel suggested.

“We do depend on the modeling agencies to also assess this risk,” Stahel said. “This is not because we cannot do it. For audit purposes, we need to have a third-party opinion on every transaction … so therefore we would welcome transactions that are coming from countries where the modeling agencies have done their research, and have people develop models.”

LGT Capital Management is part of Vaduz, Liechtenstein-based LGT, a private banking and asset management firm.

The cost to setup cat bonds is “substantial,” Brisebois said.

Lee said those setup costs include fixed expenses — such as legal costs of setting up special purpose investment vehicles — as well as fees for bankers and trustees.

“The larger you go, the more efficient these transactions become,” Lee said. “So typically as a rule of thumb you want to do something that is over $100 million.”

Lee suggested that of the cat bond deals Deutsche Bank has done, “a good chunk” go into bond funds.

“What’s interesting is, investment mangers, particularly of high-yield corporate bond funds, are large buyers in the cat bond market as a (method of) diversifying asset class,” said. Lee added that other investors include reinsurers, life insurers, hedge funds and pension funds.

“From an investors’ perspective, Canada is very far ahead,” Stahel said. “With Ontario’s teachers’ pension plan, you have a very long-standing investor in this space that has allocated a good portion of their overall assets into this space.”

One advantage with traditional reinsurance is the time primary insurers need to setup coverage, Brisebois said.

“You don’t want to have a knee jerk reaction where you say, ‘I have to implement this cat bond tomorrow,'” Brisebois warned. “That’s not going to happen.”

NICC was produced by MSA Research Inc. and held in downtown Ottawa.