Alternatives to the buffer loss table are coming to the fore, as the sector searches for answers on trapped capital

Alternatives to the buffer loss table are coming to the fore, as the sector searches for answers on trapped capital

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Reflecting the easing of concerns around a crippling property BI-driven Covid-19 loss, the pandemic slipped down the agenda at sister title Trading Risk’s ILS Week event last week.

Instead, the debate focused on more fundamental questions around the efficient and effective structuring of the product, and scope for structural evolution in the ILS market.

The implications of multiple years of heavy capital trapping was one of the main concerns raised by investors, with the collateral drag an issue for sector returns.

This means there will be a continued focus on making sure that ILS platforms have access to rated paper, whether in-house or via fronts, and finding other solutions to keep capital working.

Expect more in the way of rated paper tie-ups or in-house launches of balance sheets from ILS managers keen to address these issues.

At the same time, speakers highlighted that there is no perfect solution and that trade-offs are inherent in any choice – whether using aligned or external leverage.

While this was said in the context of an investor debate, the same principle applies on the ceding side.

It's worth pointing out that for many buyers, innovation on managing trapped capital is something that largely happens without their input. Many more cedants face a rated fronting provider than use true collateralised products, which means that how much collateral is held back is negotiated between that front and the ILS manager.

Meanwhile, the recent example of a trapped capital securitisation from ILS Capital also shows how capital may be effectively freed up by finding other parties to take on risk, without endangering the collateral security held by a cedant.

Within the sidecar market, a retro/reinsurer ILS panel held at ILS Week also discussed evolutions in structure that are circumventing the traditional buffering approach and enabling investors to manage trapped capital on a reserved loss basis.

For the cedants, this means less collateral buffer is held back in reserve, on the presumption that following year portfolios pick up any loss development – something more in line with traditional reinsurance principles.

Bespoke deals can be done to protect new investors from old losses, although exiting a transaction may come at the cost of additional trapping.

Peril coverage and duration of coverage may also lead some back to rated paper, given the brewing disputes over Covid trapping and worries over long-tail losses. But this is not a free pass as some rated carriers are introducing exclusions on pandemic even if they are not limited to named perils.

While fronted paper might be the easier answer for many buyers, ultimately for some sectors such as the stressed retro market, collateralised cover might be only too welcome where it is still available, as it is very capital intensive to write on rated paper.

Similarly for investors, although trapped capital has been a greater headache from retro portfolios, these also offer the greatest rate increases, as one of our investor panellists pointed out.

One outcome could be that structural concerns over trapped capital push some investors to lean back to simpler structures such as cat bonds, ILWs or ones with inbuilt leverage like quota shares.

For the cedants, this may also provide the relief of defined rules that do not involve buffer loss table multiplications – although there are some trade-offs, like the additional premium required to extend cat bond collateral past its due date.

The ILS market is clearly being tested and has been tested structurally, but it has shown a greater capacity to evolve than the traditional market as a young sector.

The product set is likely to continue to evolve over time but will still offer diversifying capital with a relatively low cost, so it will have a place in the value chain long term.

Playbacks of the events from ILS Week are available here.

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