Behind the ILS and cat bond prices surge – Frontier

Insurance-linked securities and catastrophe (cat) bonds have become increasingly popular investments for institutional investors over the last 20 or-so years, since the market took off due to a spate of hurricanes in the US. COVID-19 has added a new twist. There may now be a capacity problem.

According to two complementary research notes by investment consultant Frontier (formerly known as Frontier Advisors), supply and demand has gyrated as much as the weather in recent years, with about a 50 per cent increase in available capital since 2006, leading to a proliferation of new funds and structures.

The first paper, ‘Private Insurance-Linked Securities’ says: “As with other asset classes, there is a delicate balance of supply and demand. If the capital markets demand ILS products faster than it can be sensibly packaged from underlying insurance risk, quality will suffer. On the other hand, there is still a large amount of insurance retained on the books of insurers and reinsurers that can usefully be transferred to the capital markets where it can be best borne.”

Investor sentiment is also a big factor with ILS and cat bonds as much as other asset classes. The paper, written by Frontier’s senior consultant Joe Clark and associate Donna Davis, says that in 2020 there have been net capital outflows from the sector following losses in the 2017-18 and economic uncertainty surrounding the pandemic. “This has combined with increased demand for protection to materially increase premiums and expected returns, particularly for previously loss affected contracts,” the authors say.

In their second paper, ‘ILS Market Update’ Clark and Davis say turbulent market conditions surrounding the COVID and memories of recent losses (from fires and hurricanes) have tested capacity in the ILS market. “During the 2020 renewal seasons pricing reverted to the highs of 2012 levels and there is widespread expectation for further improvements in 2021. This means higher expected returns for ILS investors,” they say.

Global insurance loss estimates from COVID vary widely, with the impact expected to be felt in almost all insurance lines. The upper end of estimates is broadly accepted to be US$100 billion – although some firms are forecasting up to US$150billion – but actual global insurance losses to June 2020 were around US$5 billion.

The primary exposure in ILS is from business interruption (BI) cover provided in commercial property policies. This cover compensates the insured for loss of income arising from the business not being able to operate from their insured property.

“Uncertainty over the extent of BI losses stems largely from uncertainties of the classification of the pandemic as a natural catastrophe and the classification of the damage as a physical consequence, according to the paper.” Pandemic exposure in existing BI policies falls into three categories:

• Clear pandemic exclusions: the policy specifically excludes payment resulting from a pandemic and no loss reserving is required.
• Affirmative cover: the policy specifically includes payment resulting from a pandemic, and this payment is normally up to a sub-limit. Here loss reserving is required and is generally calculated at the sub-limit level.
• Ambiguous policy wording: these policies do not specifically include or exclude pandemic cover, raising an element of ambiguity. Several cases are currently being litigated. This is the most challenging loss to estimate and insurers and funds are currently erring on the side of caution with loss reserves.

“Typical ILS managers have loss reserves between 1.5- 2.0 per cent for these business interruption claims. The 15 per cent or so of funds with loss reserves in excess of 4 per cent are mainly higher risk offerings with large quota share and retrocession allocations,” the paper says.

Frontier Advisors image makeover

Frontier Advisors today becomes known simply as Frontier, in a makeover including updated website and loads of stationery and signage. It is the big consulting firm’s second name change. Its first was after gaining independence from Industry Fund Services – Frontier Investment Consulting – which was changed to Frontier Advisors in 2012.

Wayne Sullivan, the firm’s director of marketing and business development, who joined in 2013 from Sunsuper, says the change reflects the continuing evolution of the business. He was the first marketing resource for the firm. Dropping ‘advisors’ reflects the shift in the business whereby, while consulting advice remains very important, it is not as dominant in the range of services on offer.

Sullivan says 2013 was a big year, not only because then chief executive Damian Moloney recruited him, but because Frontier Advisors that year launched its ‘Partners Platform’ technology, launched GIRA (Global Investment Research Alliance) and started to recruit more specialist consultants. “Since then our client numbers have doubled, staff numbers have doubled, we have an in-house tech team of 10 IT specialists and an extensive team of sector research specialists.

So, it’s been quite an evolution. Andrew (Polson, the CEO) is taking us even further into new markets such that we are now basically 50/50 super and non-super,” he says.

The new name followed research conducted earlier this year and the advice of brand strategist Paul Kennedy, of Two Thirds Research, who spoke to CEOs, CIOs, investment committee members and others, with positive results. “A lot of people may not even know the word ‘Frontier’ relates to the efficient frontier (an investment chart used for optimum portfolio construction),” Sullivan said.

– G.B.

Greg Bright

Greg has worked in financial services-related media for more than 30 years. He has launched dozens of financial titles, including Super Review, Top1000Funds.com and Investor Strategy News, of which he is the former editor.