By Caroline McDonald
With the many advantages offered by special purpose insurers (SPI) for both investors and insurance buyers, it's no wonder they have skyrocketed in popularity in recent years, driving a number of new formations, with the majority in Bermuda.
Generally formed for a single transaction, SPIs are fully funded insurance entities. Through them insurers can raise capital by transferring risk for major natural catastrophes -- such as earthquakes, hurricanes or windstorms -- by methods including issuance of cat bonds to third parties.
Bermuda registered eight SPIs in the first quarter of 2013, according to SNL Financial, a provider of financial information. The Cayman Islands also licensed one class C entity, based on data from the monetary authorities of Bermuda and Cayman. In 2012, more than 40 SPIs were registered between Bermuda and Cayman, with 29 registered in 2011.
"Bermuda has done a lot to accommodate these in terms of legislation they have put in place," said John Andre, group vice president, Property/Casualty Ratings at A.M. Best in Oldwick, N.J.
Bermuda established a regulatory framework for SPIs in 2009, and is "increasingly becoming a global center for the creation, listing and servicing of insurance linked securities (ILS) that are sponsored by special purpose insurers," said Shelby Weldon, director of Licensing & Authorizations at the Bermuda Monetary Authority. "Global ILS market capitalization in 2012 was $6.4 billion, of which Bermuda issued $2.5 billion (40 percent of the global issuance)."
Weldon noted that Bermuda's new registrations in 2012 were driven by SPIs. Of a total of 53 registrations last year, 27 were SPIs.
"This trend has continued into 2013: 11 SPIs were registered by April 2013 out of a total of 20 registrations," he said.
A major reason for the increase of the ILS market is the "increased sophistication of the owners of risk," Weldon said, noting that another reason for the growth of ILS, and for catastrophe bond issuance in particular, was capacity constraints after Hurricane Katrina in 2005.
"Cat bonds have developed to cover risks that traditional reinsurance markets do not cover," he said.
Jason Carne, managing director, insurance, and head of ILS at KPMG Audit Ltd., based in Bermuda, said the ILS market offers a number of benefits to both policyholders and investors.
Investors like the "diversity and the yield enhancement," Carne said. "They are getting a lot more yield than they would in the traditional debt marketfor taking a similar amount of risk."
Added diversity means the risk of loss of capital on one of these bonds "is not linked to the financial markets or the stock market or the credit risk of the issuer. It's really linked to a hurricane hitting Miami, or an earthquake hitting San Francisco or Japan," he explained.
Also attractive is the fact that the bonds are tradable, Carne added. They are not exchange-traded, "but there are market makers who facilitate liquidity in the bonds, which is also attractive to investors. This is another reason we're seeing institutional money coming to this area."
From the purchaser's perspective, "They like having a collateralized facility -- and the pricing is attractive," Carne said. "They are able to lock in pricing over a three-year period -- and those three-year terms may not be available in the traditional market."
Robert DeRose, vice president, Reinsurance Ratings at A.M. Best., pointed out that the ILS market and SPIs provide a distinct advantage to buyers by keeping prices low.
"It's a function of supply and demand," he said. "More capacity that comes into the marketplace serves to drive pricing down. That can be a negative if you are a traditional market player not engaged in this type of activity.
"By and large, however, the majority [of insurers] have some type of sidecar, or SPV available," DeRose said.
Andre added, "At the end of the day, the buyer is the winner, because the traditional market is pretty well capitalized to begin with. Now you have more capital, so there is plenty of supply and that will help the buyer."
The only uncertainty, DeRose said, is the permanency of this type of capital.
"It's here to stay as a form of capacity," he said, "but in terms of whether it will be as plentiful as it currently is depends on the other markets and the ability to attain a good investment return from traditional investment opportunities."
"And if there are a number of losses," Andre said, "who knows if the investors will want to stay?"
CAROLINE MCDONALD has covered risk management for 15 years.
May 21, 2013
Copyright 2013© LRP Publications