Before we start, please allow for some housekeeping. On your screen, you can find different windows. Most importantly, the media player where you can see the video stream of all panelists. We won't use the slide area as there won't be any presentation. Very importantly, the Q&A box, where you can drop in your questions at any time. I will read them out loudly on an anonymous basis, obviously, and share it with the respective experts. Please don't hesitate to drop your questions at any time. This is important and the basis for this event as we strive for a very interactive discussion. In one window, you can also find the detailed speakers' CVs. For the best performance, please use Google Chrome if possible. Close programs and other sessions, tabs in the background to make best use of your bandwidth.
On the bottom of the screen, you can find a link to register for information about future ILS/ ART events. You can also simply drop us an email. One last trick, if your picture freezes or the picture of the speakers freeze or something like this happens, simply press F5 and the system will run again or close the program and log in again. We have roughly an hour to discuss about ILS and Alternative Risk Transfer in a broader context. I guess it will be a very exciting session today. Let me just mention a few highlights. What did we see in the recent past? Lost prone years, 2017, 2018, 2019, three years in a row. The big reload of capital in 2018.
Heavy redemptions, losses, loss creep, and trapped capital affecting collateralized structures, and now the uncertainty around COVID-19 and the hurricane season is not yet over. I could continue with this list, but we want to start the discussion. Let me do so by briefly introducing the panelists. I will only mention their current role as you may find more information by simply navigating your cursor to the picture of the panelist. Let me start with Ivan Bokhmat. Ivan is a European insurance analyst within the equity research team at Barclays and covers the European insurance sector and non-life insurance in the U.K. Ivan, you want to say hello?
Hello, everyone. Thank you very much. I'm very pleased to be here.
Next one is Ewoud Bom. Ewoud is a managing director at Achmea Reinsurance Company with a long-standing insurance and reinsurance background, and he has issued a cat bond earlier this year.
Yes. Hello, everybody. I am happy to be here as well. Unfortunately, we cannot meet in Monte Carlo, but I think this is a very good opportunity to have this discussion.
Thank you. Next one, Tom Johansmeyer, who is Head of PCS, Property Claim Services, our Verisk Insurance Solutions business, and has significantly expanded the PCS reach over the past years. Tom?
Thank you for having me. To the audience, don't be shy.
We have Philipp Kusche, partner and global head of ILS and capital solutions at TigerRisk Capital Market & Advisory, covering all activities around capital market solutions.
Thanks, Andreas. I'm glad to be here and looking forward to the debate.
The investor perspective today is covered by Adolfo Pena. Adolfo is partner and co-head of Nephila Capital's reinsurance division and chair of the transaction committee of Nephila, which currently has $10 billion under management.
Hello, everybody. I'm glad to be here. Andreas, thank you very much for putting this together in such circumstances.
Thank you. Munich Re is represented by Thomas Blunck, Member of the Board of Management responsible for life and health, Digital Partners, and Capital Partners, which among others, comprises Munich Re's retrocession and ILS businesses. He's right to me.
Hello, everybody. I'm very happy that all of you have joined, and I hope we can make it as interesting as these circumstances on a virtual basis allow us to do.
Finally, I'm Andreas Müller and have the pleasure to moderate this session since 2009, for 11 years now. Let's jump into the topic, feel free and drop the first question to our panelists. Surprise, surprise, it's about COVID-19. The question is: How did COVID-19 impact the ILS or ART market so far, and what did or will it change? I guess, Ewoud, would you start with that?
Yeah. Thank you for this question. Yeah. I think it's still very difficult to see what COVID-19 will bring us. I think that in the end, COVID-19 is something we never expected that would have happened to such an extent that there were this many closures. If the ILS market can offer us a solution will depend very much on the price and the demand and supply. I'm not sure which way we were heading to.
Okay, perhaps Philipp, you're next one to answer or comment on.
Yeah, sure. Yeah, no, absolutely. Thanks, Andreas. I think from our side, certainly COVID-19 is, as you mentioned, or certainly already had a substantial impact. I think we would expect that to continue. Really for kind of a number of different reasons. I think, one, it really creates a supply and demand imbalance from our perspective. I think traditional reinsurers and insurers who I think on the one side, seeing losses from COVID-19, on the other side, we have seen kind of volatility on the asset side as well, which overall I think reduces risk appetite and will lead to more interest in reinsurance capacity. I think on the capital side, given that reduced risk appetite, we would expect also traditional reinsurers to have less appetite for assuming that risk. I think the same is true for ILS markets.
I think you mentioned collateral trapping, or I think, which we expect to be another substantial issue at one-to-one, especially in some sub-segments like the retro market. I think we have seen some of that at mid-year. Then also I think on the capital raising side, due to COVID-19, I think things certainly slowed down quite a lot, given that a lot of the end investor segment is heavily distracted, I would say, from managing other issues outside of the ILS space. In that sense, yeah, certainly expect ongoing impacts and at least from our perspective, I think every segment will be impacted quite differently. I think the retro segment certainly will see different impacts than, for example, the capital market, which obviously was impacted significantly less, versus the insurance market or the reinsurance market.
Philipp, you already covered reinsurance industry, although the investors perspective too, also shed light on how you view the market currently and going forward.
Yes. Thank you. Well, it's clear to see that COVID is yet another test for the market, as we had seen quite a few in the previous years. It's early to see the final scope of losses, but at least what we've been tracking from the traditional players, it's been right now between $ 20 billion-$25 billion. Clearly on top of the usual Nat Cat losses, this will be another heady year. I think I would completely agree with Philipp. The result of that is the pool of capital is becoming restricted. There is going to be yet another, maybe a couple dozen billion dollars of collateral that's going to be trapped on the ILS side. There's certainly going to be losses on the traditional side.
All that would lead to prices rising, particularly in a situation where rather uniquely, the reinsurance market as opposed to other kind of elements of primary insurance market is seeing increased demand for cover. I think for one that therefore, calls for continued hard market momentum.
Just one question. You touched on capital raising. If we do not only look at the ILS or ART capital, could you also share a perspective on other capital, like subordinated debt or even equity in that situation?
What we have seen in the past several months, I think AM Best did a calculation of approximately $20 billion of fresh capital entering the market. That's half of this is equity, half of this is debt. Some of the capital increases so far appear to have been defensive, i.e. companies were preparing balance sheets for the ability to pay claims associated with COVID. For many others, it has been offensive, i.e. companies trying to prepare to take advantage of the market opportunities. It feels like this capital raising is probably going to continue throughout the rest of the year. So far, you could see that the stock of capital raised has probably been smaller than the extent of even COVID losses that we are considering. We've tried to make a very early estimates of between $30 billion-$80 billion of COVID losses, potentially.
It seems to be crystallizing towards the midpoint of this. Arguably, there will still be some capital removed out of the equation by the end of the year.
Okay, thank you. We have three panelists left to comment on that. Tom, Adolfo, and Thomas, who wants to take it?
Maybe I can take it and add a different perspective. COVID-19 has caught the whole industry by surprise, everybody, I think, is aware of that. The arguments, why that is a surprise have been already laid out. What I would like to add is a perspective of us as a reinsurer. When we manage our capacity, our solvency ratio, our earnings volatility, our idea is to have a continuous program with a lot of retro, but also ILS partners. You know that we have two sidecars in place. One thing that we really want to achieve is continuity. We don't want to jump in and out or being jumped in and out by such events, and then the uncertainty that this event may create in the investor community.
Having a reliable program over years is important to us, and we very much hope that COVID-19 will not change dramatically, at least, the risk appetite of the investors.
Adolfo, would you like to share the investor's perspective with us?
Well, there's no question that COVID threw a wrench in capital raising for reasons such as the practicality of doing due diligence visits and all that, which has slowed down the ability to raise money. A big clear question that is out there is whether people are being compensated for taking this risk. Starting in 2017, we started having a really poor pricing for, and what is the risk [audio distortion] that we're very carefully is to make sure that every risk that has been taken has been paid for, and that investors have been fairly compensated for it. I think that is going to be one of the things that is going to have to enter the conversation. If these covers are going to happen, are we getting paid? I don't know if I would agree to the point that COVID is a surprise.
We've been having pandemic models since the '80s, I think. The question is, have we been charging? Have the primary rates been taking into account this risk? That's the one thing to think about.
Can I add to Adolfo's comment?
Sure.
Yeah. Not COVID-19 in itself is the surprise. It's rather the magnitude of it, I would say. That is linked to your comment, has it been priced for? If I may share an example or an estimate, the average of the combined ratios in the contingency business worldwide, of the past years, I would say, indicate that it hasn't been priced for. There's one example at least where we could say, it has not been priced for, and the magnitude really was a surprise to the contingency line of business worldwide.
It's not just pricing that you need to think about with this as well. I think the most alarming thing I've heard from my clients through COVID-19 has been deal fatigue when it comes to terms and conditions. The terms and conditions discussion as a result of COVID, that's no surprise. Everyone knew that was coming. Do you treat pandemic as natural? Is it a natural peril? Fine. The tough part, though, is when you're trying to introduce these new significant restrictions that we haven't experienced much as a market. How do you do that on a tight deadline? Right now, we're dealing with the unofficial start of the 1/1 renewal season with this battle, right? Andreas, you're the one who's literally kicking off the 1/1 renewal season.
The big question is now, do we, over the next four months, have enough time to manage the terms and conditions discussion effectively? Are we going to get to right around Christmas where one underwriter or the other is saying, "Okay, you know what? We'll just take it as it is. I'm exhausted. I want to go see my family and open some presents." That to me is probably the most critical operating level driver from COVID-19 right now. The other thing that we're seeing, or we've heard about but haven't seen yet, is post-cat remediation with COVID-19. My team conducted some research back in April about how insurers were preparing to adjust claims in a social distancing environment without access to think of constraints on site visits just with scale. Right?
Far, even with Hurricane Laura, our understanding is the average insurance company or independent adjuster has not had to turn to more innovative techniques for adjusting claims. Which means that cycle time proceeds as it has in the past. Innovation remains on the sidelines, and we don't know if we can bring that in to massive benefit yet. Generally, nobody has had to change what they're doing. That being said, everyone's acutely aware of the other impacts that COVID has had on post-hurricane remediation, such as the supply chain issues that are leading to demand surge, shortages in lumber, inability to get full-size crews onto a work site because of social distancing.
Whether or not these factors increase the insured loss associated with hurricanes because of COVID, but without being directly attributable to the pandemic, that remains to be seen, and whether or not that sort of demand surge works its way into models for 1/1 could be quite interesting.
Yeah, that is what you see. Not in all countries the impact of COVID-19 in the P&C business is exactly the same. What Kusche Philipp said, that the wording and the terms and conditions are getting more and more important.
There was one interesting point, if I may raise that again. The relevance of the pricing. If the risk is priced for in the coverage. Adolfo, you brought that up. My question would be, let's assume that this is possible in a proper way. What would you think, how much capacity would be available in the alternative market, in particular, considering that the non-correlating character wouldn't be there?
I mean, that's a pretty tough question, and I'm not exactly sure. We have to think that the correlation is not 100%, which means that it would be still an attractive proposition. I'm not exactly sure. It's so many questions in one, right? It's like how attractive. If it is very attractive, obviously there's going to be a lot of capital. It depends on how much we say we're pricing for. It's a difficult question. Definitely violates the no correlation assumption, but to what extent? What would be the pricing? I'm not exactly sure.
Yeah. Well, certainly, I think more likely is probably an exclusion of the risk rather than a broad incorporation of the risk in the upcoming covers also in, at least, will there be a market for pandemic-specific solutions? I think probably, and agree with Adolfo, it's probably a price question. I think the general investors I would expect would shy away from it just for the increased correlation. Certainly, I think there's capital for almost any solution if the pricing and the margin is right. I think the broader market will, as it already has done, I think at mid-year with broad exclusions, I think. That's at least what we would expect.
We've entered the market on-
The investor community, I believe, would expect somehow reliable model to underpin any kind of pricing. I wouldn't dare to present to you guys a model for pandemic scenarios.
In the meantime, questions? I wanted to add.
The one thing we have is demand. My team says the [audio distortion] pandemic [audio distortion] and how much. The commitment would vary based on the type of original insured available. This one was somewhat immune to COVID-19 impact. What you've got here is just such a massive chasm between the original risk and how that is valued as a product. Then ultimately all the way up the risk and capital supply chain to the end investors who would be our competition for capacity, where you've got CAT is priced so high right now, some of the most sophisticated modeling out there, moving to pandemic, and it's not an easy move.
I said there are questions coming in, and there's one which perfectly fits into the current discussion. I just read it out loud for everyone here. "Will COVID-19 lead to an advent, both in insurance and reinsurance and capital markets of parametric risk transfer, CAT and non-CAT, given clarity on terms and conditions?" Who wants to take that?
I would say that as with many perils, right? When there's a lack of model credibility, the only place where you can start is with parametric. Right? If there would be a solution, you would think that you have to start on that side. You just have to take a step back. If you're going to build a model, the only way that you can build a credible model is to start at the simplest, purest form of the risk. Then as time goes by and people get more comfortable, you would move closer to something that has more of an indemnity component to it. To me, it seems like to ever be able to create a credible model, you have to start on that side.
I mean, parametric insurance, I would say, not such an easy topic, even though we see more interest on that. From a sponsor perspective, perhaps Ewoud, you can comment on that, and probably you, Thomas. I mean, you still run this business risk. I mean, what's your perspective on that?
Yeah, I try to look at this, because in the Netherlands, the COVID-19 is not a real topic. We have a lot of named peril policies. COVID-19 is excluded. From a sponsor perspective, from the company I represent, I don't see COVID-19 as a problem in the P&C business. I was also thinking about what Adolfo said about the parametric. I was wondering how you could take into account the influence the government is taking. We see several actions of different approaches in the government from a total lockdown and a lighter regime. I was wondering how you could introduce that in a parametric solution.
It'd be very difficult. You have to take a sort of parametric based on either fatalities or casualties. You need to find a reporting agent that you trust because you've got political risk in the government reporting process alone. Look at the U.S., look at Bolsonaro in Venezuela. Basically, what I would do for the U.S. is use state and local health agencies and aggregate up to the total. That's part one. Part two is defining lockdown. I've heard a lot of non-U.S. folks talk about U.S. lockdowns. It's literally impossible in the U.S. We have more than 50 governments, not one. You need to clearly define what that school closure is. Tie that to some series of specific events. Similar issues in Canada and other countries vary as well.
Europe as well.
Yeah, exactly. On top of that, you've got political risk on the front end to Adolfo's point, analytics and modeling, based on how governments will behave. I talked to a Brit recently who said, "Well, it's pretty clear that the U.S. will learn from this mistake." My response is, when have we ever? The same could be said for BoJo in the U.K. or Macron and so on. Governments don't learn from their mistakes because voters don't learn from their mistakes. How a government responds to a pandemic will have as much to do with the party in power in the election cycle as it does with common sense. In fact, common sense probably suffers the most. Add to that, the scarcity of capital, On top of that, likely thin demand. I'd love to see a parametric market pop off.
I've done a lot of commentary on it the past six months. The reality is, I'm not that optimistic. I think that its basis risk aside even, I think it's a difficult proposition on short notice with political risk being through the charts. You'd need a political risk indicator built into that trigger.
Yes. As a sponsor, it's also necessary that you have somehow a good feeling about the link to the parametric solution. Is it really something that is matching the development of your losses?
What I would say is, rather than take that approach, forget about matching the loss to your book. I would use a parametric as a one instrument hedge, basically saying, "Things are going wrong. You know what? If things are so bad that my book is so deteriorated, this parametric will get me a fast injection of capital into the problem, even though I've got a much bigger problem to deal with later.
Yeah. Could be.
There is one question coming referring to more structural topics of cat bonds in relation to pandemic, which says, does it make the return period, the modeling, et cetera, make the pandemic unsuitable for ILS coverage? I guess that could be something for you, Philipp.
Yeah. Certainly, I think I agree with Thomas. I think that the modeling component and then having independent models available certainly is important for the cat bond market in particular, which I think much more relies on independent metrics. In that sense, it's, I think, not too dissimilar to cyber or terrorism or other kind of perils, which maybe kind of are more at the less developed kind of range of risk spectrum. I would say that's really the biggest challenge, I think, especially given that these are non-proportional kind of type covers and that's probably what's needed in the cat bond market. I think pandemic solutions, unless they are really more mortality focused and for more tail events where you can capture kind of movements in the mortality rate, I think we don't see kind of immediate on the pipeline.
There also seems to be the problem that the pandemic cat bonds appear to offer the least advantage of uncorrelated returns, it would appear. I think clearly what we've seen, this financial markets collapse as the pandemic risk became real and so with the bonds with the underlying risk.
It's a one issue, right?
There's another one fitting perfectly into that topic. The question is referring to the length of the tail, where do investors see that in their portfolio? How will capital get the appetite for such?
I was going to say, I hope you didn't ask me. It sounds fairly complicated, right? The thing is, as we're seeing in COVID right now, I think we've just gone through the first season of it, when we don't know whether there's going to be more seasons coming. If you go and look back at the flu pandemic at the beginning of last century, that is something that lasted all in three years. You can see that it's a real issue of capital trapping, and it would be one that you would have to solve before going into it. At Nephila, we've been around for 20 years, so this whole idea of trapped capital, trapped collateral is not something that is new to us. We've just figured out ways to deal with it.
I would say that if you're going to enter into a transaction where there's a potential for a long tail like that is something you need to solve before you decide to enter. It's not something that you should be thinking about after the fact. There's so many things to think about there, right? There's the tail. When I hear tail, I think that you're talking about the duration of the risk instead of the tail of the distribution. That's something that needs to be engineered for. I think in that point, I would just point it back to Philipp, because he probably has a better idea how you would deal with something that has a long tail, and you would turn it into a short tail proposition.
Yeah. On that point, I think that there's really two questions. I think one, how can you design a solution for a product like this going forward, to Adolfo's point? There's obviously potential ways to deal with that. I think the more important question maybe is really how will COVID-19 affect collateral trapping at the moment, and especially into 1/1? I think since the June and July renewals have provided a little bit of insights to that. I think certainly, and again, I think every market segment will behave quite differently there. I think the retro segment and especially the aggregate kind of type contrary to the cat bond market, for example.
I would like to add one perspective here. Recently, in our risk committee at Munich Re, we had a discussion about that topic. We do see the downside for the investor, which is a lower return definitely, and it would need to be priced in again. On the other side, the downside we see for ourselves or for the one that is in reinsured or insured via such a construction is, if then the reserves exceed what is being determined in the loss table buffers, and you sit on a loss that should have been shared, but then there's no payback from that's a big negative from our perspective when we are looking for protection.
I guess this is one of the gaps where a bridge needs to be built to really bring the interests of sponsors and investors together. Happy to take any ideas or even solutions if you have. Anyone on the panel who wants to comment on that gap, referring to the interests of both sides?
Yeah. It doesn't matter the metric. It really is as long as you can find sponsors who could accept and pay for the basis risk and the novelty risk. The biggest problem we've seen with parametric pandemic, which we've also seen with cyber and other newer risks, is that you've got seasoned sponsors who have never had to pay for the cover in place. Right? It's always bundled in or lumped in or unspokenly chucked in. They want to pay as little as possible because it's unbudgeted relative to past expense. You've got investors on the other side who want to charge a novelty premium, who are fine with basis risk, and who are going to deploy either to this new novel risk or to short-tail cat, which is paying really well and is well-modeled.
The biggest opportunity, I think, for a bridge, Philipp, would be for you and the broking community to sit in the middle and actually bring these two sides together and say, "Okay, lets [audio distortion].
Again, I think from our side, there's certainly, again, a lot of different topics within this discussion. There's one, how do you design an efficient solution for pandemic kind of going forward, and can it be parametric, and what's the best way? I think the question about the buffer tables really, in our mind, I think has to be subdivided into, is it a more proportional type relationship or where I think there are some increased mechanics in place to allow sharing of collateral in multiple years and things like that. Versus kind of the more non-proportional market where, again, I think you're generally in a collateralized structure, certainly subject to some collateral holdback, and then that's more difficult to engineer in that sense, unless more rated platforms or other structures are kind of being used.
Which I think is another trend we're clearly seeing in the ILS market, where I think the move kind of, to some degree, away from a single collateralized platform to multiple platforms is clearly a development, I think, which will further accelerate.
We've talked a lot about COVID-19, and COVID-19 related topics. There are no further questions from the audience on COVID-19. One which leads over to a very interesting topic I would call innovation. Let me quote this one here. Besides topic around lack of modeling capabilities and data, et cetera, why are there no more ILS transactions for cyber or other covers other than Nat Cat if the capital supply is there? I guess this is something where everybody can respond. Probably I would be interested to get Ewoud's view at first, perhaps. I don't know whether you made up your mind on different risks you would think to bring to the market. Here it was mentioned cyber, for example, but there are other casualty risks, et cetera. Is there a kind of, let's call it wish list or so, which you would have in mind?
Yeah, we are constantly thinking about how this market could help us in new risk. It can be also more type of life risks. That's also one of the reasons that we entered the ILS market again with the 144A transaction we did earlier this year, Windmill. I think this market is very important, and I think for us it's necessary to know that market better.
I don't want to sound arrogant, but I think it's also important that the ILS market knows Achmea better. You mentioned cyber. We as an insurance company are also struggling with cyber. Cyber is one of the key risks for c ommercial and industrial risks, but we don't see a real demand of companies that are buying this kind of covers. In our case, the exposure we have for cyber is still very, very limited. We know that cyber is one of the most important risks they have to find protection for.
Thank you. Comment on that.
The lack of ILS capacity is the single biggest constraint on the growth of the cyber market right now. Insurers don't have enough capacity to fuel all the demand from original insurers, let alone the pent-up risks that are in the reflected in original insurer demand yet. Reinsurers are filling their boots pretty fast and can't allocate more to insurers. Let's get real. Insurers are relying on reinsurers. Approximately 40% of original insurance cyber premium is ceded to RE. All right? Insurers can't grow without reinsurance affirmative cyber growth, and reinsurers are doing these small bespoke retro deals and can't get enough retro out there. Why not? Because everyone's writing the same stuff. The reinsurer turning to a retro writer is probably on the same programs. They don't want to share their data with each other. Retro doesn't happen in that regard. What do you need?
You need new, fresh, non-correlated capacity to come in and fill the gap. The biggest problem there is price. Cedents and even retro cedents still don't want to pay. You take the ILS bond and you look to Adolfo there, are you going to get the returns on cyber that you will on Florida wind? You're not going to find a ceding who's willing to pay that until they should have to. What you need now is, again, a meeting of the minds here where the market can get real and say, okay, I as a ceding know there's a downstream market opportunity that I can capitalize if I actually pay a reasonable price for retro. You know what?
Yes, my initial price is the most I'm ever going to make before the brokers beat me down and the cedents beat me down, but I have to pick a more realistic insertion point. Do that, and we're close to it. Do that, and the cyber ILS market just runs like crazy. We know there's demand. In Q1, we got to the first realistic spread we've ever seen on a cyber ILW, literally to within 3 percentage points between ceding and the markets who are bidding. Usually, it's about 10. It's still too far, and then COVID mucked it up with uncertainty with capacity driving prices up. Up until that point, you know what. We hadn't an opportunity. If we don't get that right in 21 as a market, the cyber market will remain fundamentally dysfunctional from my two cents.
Thank you. Ivan, perhaps you could share from your industry perspective where you deem it most probable or most reasonable where the ILS/ART market should expand into in order to add value in the overall insurance and reinsurance community, and perhaps you, Adolfo, then can let us know whether you deem that as realistic?
Maybe first I'll add to Tom's point where I think on the capital availability, well, clearly the amount of fiscal and monetary stimulus that we have just seen over the past several months, I think will to a large degree, take care of that, I imagine in the next 12 months-24 months. Already if you look at property risks, the coupon less expected loss is around 5%, whereas the yield on a BBB dollar debt of a similar duration is sub 1% or around 1%. It is indeed the question of price and there are multi-strategy investors who, I think over a certain period, will start delegating a lot more money. As to your question, Andreas, it seems like there is now demand for two things from the reinsurance capacity perspective from cedents.
If I'm maybe so arrogant as to give my view, it seems like you have the protection for the balance sheet, you have the earnings volatility protection. Far the ILS markets has been mostly helping out with peak risks, helping on both sides, it doesn't really help to write the long tail lines as well. This is a perennial debate, of course, about whether you could see casualty ILS of certain style. Maybe I'll just leave it there. That seems to be a huge part of the market that doesn't have an effective backstop.
Thank you. Adolfo, your assessment?
Yeah. It's funny. You just brought up a great point that I was trying to make. We're talking about whether there is demand to transfer cyber risk. Through all the interventions from every panelist, I got the impression that what we're talking about didn't sound to me like at any point anybody was saying there is a real need. Like this is a new peak, that it could be beyond like an earnings protection. This is a real capital protection purchase. It seems to me that until we get to that point, there isn't really a demand, right? Until it gets to the point where, because this is a capital protection issue, the insurance upfront are making sure that they're charging for that use of capital.
They decide that, okay, we have enough of this risk that we need to transfer it to somebody else. The demand isn't RE, I'm going to charge a fee for doing it. That's not really what ILS is here for, at least not what it originally was here. ILS was here to just transfer the peak risks into deeper pockets beyond what the insurance and reinsurance market could do. Obviously, cyber is a risk that has the potential to become a new peak. Based on what I'm hearing here right now, it doesn't seem we're there yet. Does that make sense?
It does. I think what I'd qualify that though, with Adolfo, is that the market can't grow yet to the point where it can become a peak risk to be transferred because it's so fundamentally dysfunctional. I think in a more normal world, we would just see insurers allocate a more realistic amount of capacity, not rely on a ceded RE so much in order to manage that market. My understanding is cyber is ceded at 4x the rate of CAT, for example. That tells me, A, there's not enough money there. They're over-relying on reinsurers. Also, they're not investing in this market the way they would for a CAT or other established lines.
To your point, yeah, it sounds like insurers are relying on reinsurers and then ultimately, later, we get ILS funds to assume the bulk of the risk and establish that market without taking a significant chunk of that risk themselves. If ILS were to step in and say, "Hey, you know what? We can provide some capacity here to help you grow. But ceding to reinsurers, you're going to have to pay for the privilege because this is a lot cheaper than what we should be doing, which is allocating significantly more capacity to that market.
I can confirm what has been said just by Ewoud, Tom, and Adolfo. I'm convinced it will become a peak risk. I don't know if that's going to happen in five years' time or maybe 10 years' time, but it will happen, and it's growing really at a very fast pace. Ewoud is absolutely right. Within our reinsurance portfolio, it's still diversifying very well. Capacities we allocate are quite small per risk, are still small to medium in aggregate. Again, there's no real need to develop a retrocession market for us right now. If the growth continues like we expect, there will be a need, or we simply have to restrain our underwriting approach. Again, how we are trying to manage it together with our insurance clients, insurance partners, is the way it has been explained. It goes far beyond capacity and earnings volatility.
It's about a common product development, common development of services, therefore shared risk on a proportional basis together with our clients. I would conclude, cyber is still in the early stages, therefore, this is the way it is. It's still small compared to the other peak risks of the world, it will grow into one. Definitely, there will be a need for retrocession markets or for ILS opportunities.
That topic, innovation, new risks, et cetera, where you still have to develop risk profiles, develop data sets, et cetera. The question says flight to quality found its place in many headlines over the last 12 months, and even more recently. What does it mean, and what are the criteria for being assessed as a quality player? Ewoud, you just did a capital market transactions a couple of months ago. I guess you could also-
Yes
take that one first.
Yes. Of course. Thank you. We have a very good relationship with the traditional reinsurance transparent as possible with our risk data and our loss data. We shared with them a lot of information. Actually, what we did with the ILS market was exactly the same. We shared exactly the same information with them. Bearing in mind that we do not buy cat bonds because there is not enough capacity in the traditional market. We think that this is a very good basis to find a solid ground and a robust relationship for the longer term. I think if you want to have a relationship for the longer term, you need to be transparent. We think it's very important to do it on an indemnity basis. Therefore, the quality of the data and the data we shared with them is very important.
I think if you are purely on a parametric, then the quality of your information is not releIvant.
That's the point.
Yeah.
That's the point of a parametric or an industry loss, is that your data's not relevant because you're protecting your intellectual property and your competitive advantage and making the transaction easier to digest with an independent third party as the reporting agent.
Yeah.
I wouldn't say one approach is better than the other, but they serve two different purposes.
Yeah, exactly. They serve different purposes, but we prefer not to have a mismatch between the model output and the actual loss if it happens.
Yeah, I agree with Ewoud. Some audit committees and risk committees don't like a basis risk.
Correct.
I wouldn't say that's universally true. We see plenty of basis risk-heavy transactions executed regularly. I think it has a lot more to do with a company's strategy for assuming, managing risk and capital availability, and what they hope to accomplish. I'd take to Adolfo from here. I'm a biased party, of course.
No, I would agree. I agree with you. I agree with Tom. It's different ways of buying, and it's just different objectives. There's people who are more than willing to take the basis risk. There's so many people that transfer risk that they know that if a certain scenario happens, whether it is their book or whatever, they know they're going to take the loss. They're more than happy to say, "Yes, there is basis risk here if you look at modeling, but we know that if things get to that level, we're going to take a loss that is probably in excess of what we're getting." What's the point of trying to match the modeling output? They just know they're wearing the risk anyways.
Yeah. In fairness, what modeling output would've shown the development on Irma? Basis risk may be a problem, but if you're going to have decades of development, my son is going to sort out that loss, not me. I would say that audit risk would need to balance loss development, tail, and duration of that post-settlement process and realize that a balanced approach that does have some accelerated claim velocity may provide some cash flow benefits, some strategic alternatives, the ability to redeploy, and so on and so forth.
I guess it also pretty much depends on whether you get the volume you're reaching out to your market and at which price, obviously. The decision probably is easier to also think about other triggers and mechanisms.
I think it's fish or meat. You cannot compare them. Some people prefer meat and others prefer fish. I think people, each other, should not try to convince some meat eaters that fish is lovely. We choose on purpose for an indemnity-based transaction to avoid the basis risk.
Some enjoy fish, some enjoy meat, and in Q4, you're going to find out that you'll eat what you can get when you're hungry.
Yeah. Absolutely.
There is one interesting-
Every food is good.
There is one interesting question coming in referring to the cat bond market as such. The question is, how far are we away from a really functioning secondary market, and what needs to be done in order to get there and maximize appeal to the whole spectrum of investors? I guess this is a very interesting one in particular, as we've seen this dynamic market, cat bond market on the trading side mid of March. Who wants to take that as the last question from the audience?
Andreas, maybe I can start. Certainly, as you mentioned, I think a robust secondary market certainly is helpful and appreciated but, similar to your comment, what occurred in March is really also a robust primary market in that sense, and then that the two are not directly functioning basically in parallel. I think what needs to happen to further increase it is really more volume in general, I would say, and more investor participation also outside of the core participant. Everything else will grow naturally with it.
I guess we can allow for one additional from the audience. It refers to jurisdictions out with new ideas forming hubs for ILS transactions. The question is, what's your opinion on new regimes entering the ILS market? Do you see increased interest there? I guess this is something for you, Philipp, as well as probably Ewoud. I don't know whether you've looked at different locations to set up the SPV. Perhaps you can both comment on that.
Yeah, maybe I can start. I mean, generally, I think variety is always a good thing in that sense, as long as it's tested and robust and that, so certainly I think transactions generally run on a fairly tight timeline, and enterprises and approval processes and things like that certainly ideally are minimized. I think the important thing is really the robustness of the process and also any kind of regulatory risks surrounding that. I think having more jurisdictions available, like the U.K., for example, might be more familiar to some sponsors. Again, in our mind, that's more a secondary development and importance to the marketplace.
Ewoud, would you like to comment on that as well?
When we started the discussions internally about renewing the cat bonds, we also considered the domicile. As you probably know, our first two transactions were private deals, and were both domiciled from Windmill Re in Bermuda. When we took all the regularity aspects and also the tax implications, or the interpretation of the tax laws into account, we favor for having a carrier domiciled in the Solvency II European area. That's why we choose for Dublin, Ireland.
Okay. Thanks a lot. We have still three minutes left, and sorry for not taking the last questions which were dropped to my screen, because the last one is a routine. It's always the same. Speakers who listened to our event in the recent past actually should have an answer prepared. The last question to everybody on the panel today is, as always, what would you expect the market to be in five years from now, and how would you like the market to be? Ivan, would you like to start?
I think I will probably not be entirely surprising. I think the market will be larger. I think there is going to be more money chasing financial assets. Therefore, the pool of capital, with better models, will probably be able to better address the needs of the cedents and the reinsurers. In terms of would we like to be more classes, and more risks covered, I guess, very clearly so, obviously you've touched on cyber. I'm sure it's going to be more than just property. The pace of this, I'm probably not the best person to judge as to how quick this could happen.
Thank you. Tom, how about you?
I think over the next five years, what I'd prefer to see and what I think will actually happen are a broad increase in perils. Again, not to the extent where it's going to seriously erode the share held by the stuff that's out there now. But you will see cyber ILS with scale. You'll see Japanese index transactions with scale. The reason you're going to see all this is because my team and I are going to make it happen.
How about Adolfo?
I would say that definitely agree that it's going to be a larger market. There's going to be more capital flowing in. It should be broader. There should be other perils as there is new peaks or semi peaks coming up. There should be ILS solutions coming to it. For all that to happen, another thing is that it should be more streamlined. The placement should have a lot less touch from the beginning of the transaction to the ultimate risk bearer. Meaning from the buyer of protection to the person providing the capital to cover that. It's going to be more streamlined, and for that to happen, there's going to be a lot more transparency and a lot more data dependency.
Thank you. Ewoud, would you like to say something?
Yeah. Besides the points that were already addressed, I think in five years, the friction costs will be lower than they are now today. Maybe the data will be more robust by using blockchain technologies. On top of that, I think also more perils will be introduced into market.
Philipp?
Yeah, no, I would agree. Certainly, I think that we would expect the market to grow as well. I think the low interest rate environment and I think the continued appeal, I think from investors of the ILS sector because of its non-correlation even throughout COVID-19, I think will remain. Yeah, certainly agree with the growing market. I think hopefully we see continued development on the product side, which I think, yeah, will cover more lines of businesses, but also will bring more risks into the marketplace and hopefully bundled with also trading abilities to capture some of kind of all the long tail lines and specialty lines as we have seen already in some segments of the market is something we kind of are certainly working towards and hoping for.
The last point maybe to make as well is I think we will see more investors participate in the market. I think we're seeing increased interest from institutional investors to form partnerships and understand the market better. Given that alternative asset strategies will grow, certainly, those discussions will kind of continue in our mind.
Thank you. Last but not least, Thomas.
It's hard to add anything. I mean, especially against such a consensus on how you see the outlook. Maybe a few items. I think the ILS market and our industry will continue to learn and hopefully further develop to get terms and conditions right, clearer, transparent, and make more independent modeling available, especially for the peak risks. That is the foundation, of course, for more ILS opportunities. I think it's going to be only a gradual development. Maybe one or the other setback is already out there in the next few years. Who knows? It can come and go, but the long-term trend is growing. On COVID-19, I think the solution is more in the direction of a state support and development of pools where in private-public partnerships, the insurance and reinsurance industry can take a share and can help to build that up.
On cyber, I wish that we really develop a strong ILS market because I do foresee that as one of the real big peak risks in the next few years for the whole world.
Well, thank you. With that, ladies and gentlemen, I would like to thank all the panelists for the time, providing the individual views, thoughts, et cetera, and close this session officially. Also, thank you to the audience for participating at Munich Re's 12th ILS or first virtual ILS Roundtable. Stay safe and healthy, and hopefully we will meet for the 13th roundtable in Monte Carlo again. Remember, always Mondays between 10:00 A.M. and 11:00 A.M. Thank you, and bye-bye.
Thank you.
Thank you.
Thank you.