Nearly 12 months on from the introduction of the UK’s insurance-linked securities legislation last December, we investigate how the market has developed
Uncertainty surrounding Brexit and the threat of a no-deal scenario has dominated recent headlines in the UK. But while the importance of successful negotiations with the EU cannot be understated, there are other factors in the UK market that are just as deserving of attention.
One of these factors is the insurance-linked securities (ILS) framework, which was signed into law at the end of December last year in a bid to attract ILS business to the UK and allow insurance and reinsurance firms to transfer risk to capital markets meaning businesses and consumers could manage their risk more effectively.
Preparations for the legislation began in early 2015, when the then Chancellor of the Exchequer, George Osborne, announced in the March Budget that the treasury would work with the Prudential Regulation Authority (PRA), Financial Conduct Authority and the London Insurance Market in order to design a new framework to attract ILS business to the UK.
The creation of an ILS taskforce, set up by the London Market Group (LMG), swiftly followed, bringing together representatives from the treasury, insurance and reinsurance firms, law firms, brokers, and specialist ILS fund managers.
Draft ILS regulation was published for consultation in November 2016 and almost a year later, in October 2017, draft legislation was laid before Parliament. The Delegated Legislation Committee approved the Risk Transformation Regulations 2017 and Risk Transformation (Tax) Regulations 2017, which made up the ILS legislation, by a unanimous vote on 29 November of that year and the regulations came into force on 4 December 2017.
Traffic
The first ten months since the introduction of the legislation has seen two structures formed. First, in January this year, Neon launched NCM Re, a protected cell company (PCC) set up to enhance Neon’s global reinsurance offering to its clients.
In June, Atlas Capital UK 2018, became the first catastrophe bond issued using the UK ILS regime. Sponsored by SCOR, the cat bond was created to provide the group with multi-year risk transfer capacity of $300 million, between June 2018 and May 2022, to protect itself against named storms in the US, earthquakes in the US and Canada, and windstorms in Europe.
Malcolm Newman, chairman of LMG’s ILS taskforce and managing director of SCOR’s Europe, the Middle East and Africa hub, says the issuance of two structures on the UK ILS regime within the first year is “good news”.
He explains: “We didn’t expect that many, due to the short time available between the legislation being passed in December and the 1 January deadline. In reality, we have always viewed 1 January 2019 as the target date for UK ILS issues, so the fact that we’ve had two already is good news.”
“There are at least half a dozen firms currently talking to the PRA, so I think there could be a little rush of approvals before the end of the year. It is encouraging though that there are a number of ILS conversations underway at the moment.”
Rhodri Lane, head of international capital markets at Aon Securities, agrees with Newman.
“It is still early days with the UK ILS market,” says Lane, “but the fact that we have seen Neon sponsor a sidecar and SCOR sponsor a cat bond from the new regime is very positive.”
William Hogarth and Garrett Moore, partners at Clyde & Co, suggested that the first 10 months had fallen short of the expectations of some people within the industry.
Hogarth and Moore explain: “The level of activity of the new UK ILS regime has not been as high as some had hoped for initially but we are aware of a number of projects in the pipeline and there are strong signs that the flow of transactions being placed through London will grow.”
After its maiden 10 months, there appears to be a great deal of optimism surrounding the UK ILS framework and market but it is far from the finished article. Brendan Roche, global leader of ILS and special purpose vehicles centre of excellence, Marsh Captive Solutions, describes the legislation as “a good starting point for the development of an ILS industry in the UK” and says that the market “continues to evolve”.
Lane predicts that this evolution will come as the market continues to grow and as the UK’s framework sees more use. He states: “For now the initial framework of the market simply needs to be used more and, thus, tested.”
Impact of Brexit
Brexit remains an unavoidable subject where the UK is concerned, especially as Theresa May’s government continues to struggle to find common ground with its EU counterparts. Despite Brexit being a polarising issue that is dominating the attention of both the government and regulators, Hogarth and Moore remain confident that it will not have a negative effect on the UK ILS market.
They say: “We are confident that all interested parties in London and the rest of the UK will work to ensure the continued resilience and growth of the UK insurance market as a whole, as well as the fledgling London ILS market.”
Newman also expects that its impact on the UK ILS market will be minimal. “The ILS is effectively a reinsurance vehicle,” he explains, “and reinsurance can be done across borders.”
“We’ve seen with the SCOR cat bond issue that Europeans are not concerned about having an ILS within the UK even if a hard Brexit occurs—and the UK ILS legal form will continue, unaffected. We don’t see Brexit really having any negative impact on UK ILS.”
According to Roche, European cedents could see an impact from Brexit. He states: “As a Solvency II regulated market, the UK is attractive to European cedents looking for certainty of regulatory capital equivalence. Post-Brexit it will depend on whether the UK retains Solvency II equivalence as to how this will impact European cedents.”
Roche also believes that leaving the EU may provide the Prudential Regulation Authority with more flexibility surrounding its authorisation and supervision of insurance special purpose vehicles (ISPV).
“They therefore may be better placed to provide options to ISPV structures and better utilisation of the PCC to aid speed to market for transactions.”
PCCs
The UK ILS framework legislation, the Risk Transformation Regulations, also introduced PCCs as a legal structure, a first for the UK, and something that Roche suggests could open up opportunities for other sectors of the finance industry to consider options in UK ILS.
Roche explains that the structure could also “facilitate the development of collateralised reinsurance in the UK. This form of ILS allows for speed of execution as the PCC will be authorised for a range of underwriting scenarios and will use standardised documentation to allow a faster route to market for all parties”.
Lane added: “I would expect to see some of the major PCC platforms establish vehicles in the UK to allow their clients to deploy capital for various ILS structures via a UK vehicle.”
Looking ahead
The general consensus is that the first 10 months of the UK ILS framework and market have provided a good starting point, something to build on moving forward. Newman says that the aspiration has to be the UK becoming a location which is considered amongst the top ILS marketplaces in the world. That, he says, is not something that can be achieved by “just competing for US property cat bonds”.
“It has go to do something different,” says Newman. “Europe is certainly one focus as not many Europeans have gone into ILS in the same way Americans have. I’m hopeful that something will come out of Lloyd’s, where there’s some creativity around capital sources and usages. I’m hoping that Lloyd’s will look at ILS and come up with some creative ways to get third-party capital in. If this happens then this will be truly different to what we’ve seen before.”
According to Newman, ILS also continues to have the full backing of the UK Government. He states: “The ILS task force is still active and we had a meeting with the PRA and various other parties recently to ensure that we continue to learn and progress. The treasury also attended, showing that there is still strong government support to make this work. I think the Government is still 100 percent behind us.”
Roche predicts that the UK market will see a more varied scope of perils being covered as more activity and continues to develops, and the PRA become more comfortable with ILS structures, we will see a more varied scope of perils being covered.
He says: “To date, ILS has been predominately used for natural catastrophe risk, but opportunities for other low frequency, high impact events should be considered, including some of the speciality Lloyd’s markets, marine, and then looking longer tail to casualty and life.”
“ILS could be used to fund some of the short-tail risk in these markets as investors look at ways to lock in funds for longer terms with potential for better rates.”
Hogarth and Moore echo Roche’s prediction on the diversification of the perils covered by the London ILS market in the future.
“There is a great deal of optimism that London’s position as a global investment centre,” say Hogarth and Moore. “Coupled with the London insurance market’s expertise and ability to innovate, will see growing opportunities for ILS to cover new and more diverse risk and access more capital.”
“While the new UK ILS regime is not seen as a replacement for Bermuda as an ILS centre, there is consensus that London, with its direct access to capital markets and the London insurance market, could grow to complement Bermuda and other ILS centres by making ILS capacity more available, and providing the talent and environment for ILS innovation.”
