The Bermuda Stock Exchange (BSX) has come a long way since it started working in the insurance linked securities (ILS) space ten years ago. Within two years, the exchange had listed a respectable 25 structures with a total value of US$3.373 billion. In 2017, the total number of ILS listed securities reached 227, with a nominal value of US$25.99 billion.
Bermuda is an obvious location for the creation, listing and trading of securitized insurance-related structures. As the world’s third largest reinsurance market, backed up by years of reinsurance experience and knowledge, the island is now considered the domicile of choice for capital markets to invest in securitized risk transfer vehicles.
The BSX has played a key role in Bermuda’s success in supporting global market transactions, and currently has 249 ILS vehicles listed, with an aggregate market capitalization of US$28 billion. The reported outstanding value of the market is approximately US$33 billion, which means the jurisdiction now has a global market share of approximately 85 per cent.
In 2017, 24 special purpose insurers (SPIs) with reinsurance exposure mainly consisting of catastrophe bonds, collateralized reinsurance and sidecars, were issued in Bermuda. There were 103 new issuances of insurance-linked securities (ILS) listings on the BSX with a nominal value of US$11.54 billion. This represents a 69 per cent increase in the number of new securities listed in the year and an impressive 87 per cent increase in the nominal value.
These results have underscored Bermuda’s lead in this asset class, and 2018 promises to continue breaking record issuance.
Growth and Potential
Large inflows of capital from retail and family offices, endowments or foundations and pension funds have driven growth in the sector, with investors coming from across the US, Europe and Asia.
In the last ten years, ILS has grown its share of the natural catastrophe market and has also penetrated other exposures as newer financial techniques have been developed. However, when it comes to notional issuance, ILS remains small compared to traditional capital markets.
Aon Benfield estimates that the broader alternative capital market space reached US$89 billion at the end of 2017. This lies in contrast with OECD pension fund investments which achieved a staggering US$25.4 trillion at year-end 2016. Persistent low yields is one reason why pension funds find ILS an attractive asset class.
It is fair to say that in 2017, the ILS market was tested and that it proved to be resilient and able to respond. Last year’s infamous hurricanes Harvey, Irma and Maria, together with the devastating earthquakes in Mexico served as stark reminders of the importance of insurance protection when it comes to risk management – and was a defining moment for both Bermuda and the ILS sector as a credible risk management resource. There has been no material drain on capital, which should give investors even more confidence in ILS as an asset class.
While many would like the market to develop more quickly, the pace has so far been more measured, with the majority of BSX-listed ILS vehicles being property-catastrophe risks. That said, new issues have come to market that exhibit regional diversification - for example, the BSX has listed bonds on the exchange that cover Turkish earthquakes and Chinese-related catastrophe risk.
Bermuda’s strength as a globally respected place to do business has created many advantages with respect to ILS. The Island’s regulatory regime is certain and it also shows the commitment of the Bermuda regulatory structure in continuing to meet, and indeed exceed, the most robust international standards. Bermuda’s emergence as a premier offshore domicile has been decades in the making, supported by the island’s speed to market, tax treatment, as well as years of expertise in property-catastrophe risk, catastrophe modelling, actuarial and underwriting. The island has built a reputation for blending new capacity, new ideas and new talent with traditional reinsurance.
The Global Protection Gap: ILS Solutions
Over the past ten years, the global capital markets have become more comfortable with ILS as an asset class and as a strategic part of their investment portfolio, which presents an interesting window of opportunity for capital market-based structures to provide cover for some of the least insured or hardest to insure risks in the world.
The ILS market is in a prime position to help close the protection gap that exists in the insurance markets and to drive more capital to areas in the word where insurance is most needed. Swiss Re has estimated that the protection – the proportion of natural catastrophes that are non-insured - is at least US$180 billion. As the protection gap grows and climate change increases, there will be growing opportunities for ILS to create solutions for these risks.
Emerging markets are becoming more dominant, and we can predict that there will be increasing commitment among governments, industry, financial markets and stakeholders to work together. Bermuda has a proven track record of agility and flexibility, which means that it is positioned to continue to be an innovator for insurance and reinsurance risk.
ILS Market Trends
In recent years, the ILS market has seen capacity move beyond private equity investors to family offices and pension funds. This trend has accelerated in the decade since the financial crisis, and one factor driving this has been that more pension funds globally realised that many assets were previously miss-sold as low-correlating assets.
Three main factors contributed to the ILS market's enlargement. Firstly, ILS was tested by loss events in 2011 and 2017, giving investors confidence in the asset class. The second reason is that ILS assets have grown substantially since 2008. There has also been an increase in the number of professionals managing ILS strategies. The third reason for growth is new financial engineering solutions have been found to enable ILS capital to be applied to other risks beyond natural catastrophes.
These forces are unlikely to change in the short to medium term. The ILS, reinsurance and insurance industry as a whole will see lower results due to the lowering of barriers to entry.
As a result, there will be fewer insurance and reinsurance balance sheets as re/insurers seek scale to enable them to manage their expense ratios on reduced margins on the underlying business. At the same time, there will be more ILS capital coming to the market, attracted by the prospect of investing in non-correlating returns.
ILS Market Talking Points in 2018
Looking at the ILS market in 2018, one key fact is that rate increases were not as high as had been anticipated. Another trend was that the capital of traditional reinsurers was not significantly impacted by the natural catastrophe losses of 2017. There was significant interest from existing and new ILS investors and many reloaded for June 2018 Florida business.
The first quarter of 2018 was a record for ILS issuance, illustrating that the market had bounced back from the losses of 2017. Finally, much of the M&A activity we saw earlier this year showed that ILS was a strategic motivator among acquirers, allowing broader access to alternative capital pools and lower reinsurance costs.
Bermuda will keep on doing what it is doing – developing a solid platform as a significant reinsurance hub and looking for ways to expand to support the global market. Moving forward, the island will see where we can use collaborative force and additional support to grow business in Bermuda.
Greg Wojciechowski Greg Wojciechowski is the President & Chief Executive Officer at the Bermuda Stock Exchange. He also serves as the Chairman of the Financial Intelligence Agency in Bermuda. Prior to joining the Bermuda Stock Exchange in 1993, he held management positions at three large US brokerage firms.