Bermuda Insurers Expect a Limited Role for ILS

Bermuda-based reinsurance companies will continue to dip their toes into insurance-linked securities (ILS) and alternative capital structures such as catastrophe bonds and side cars.

However, they doubt they will supplant traditional equity as a source of risk capital any time soon, according to industry professionals.

Even in the event of a large capital depleting catastrophe, Bermuda professionals expect that alternatives will remain just another “arrow in our quiver” rather than a significant pipeline of new equity.

“Reinsurers have gone through a process [with capital markets solutions] of bewilderment, to needing them, to issuing them, to being concerned now that we can’t issue them going forward,” said David Cash, chief underwriting officer of Endurance Specialty Holdings. “Currently, the proper source of capital turns out to be good old fashioned equity.”

Cash and other reinsurance professionals made their comments at the Annual Bermuda Financial Services Conference held this week in New York.

In the near term, insurance companies in Bermuda will likely protect their balance sheets rather than move into new catastrophe bond issuance.

Cash explained that over the past nine months reinsurers have marked-to-market their investment losses from the financial meltdown and have slowly restored their capital-base.

“We have come from being capital depleted to capital rich in a short period of time,” he said. “While most [Bermuda reinsurers] don’t need the capital today, they realize how how difficult it is to come by. That means they will be retaining earnings and holding back issuing cat bonds.”

When catastrophe bond issuance does begin to grow again, Bermuda reinsurers see it as an opportunity to gain more business rather than supplanting traditional capacity, said Jonathan Kim, senior vice president an general counsel of Montpelier Re.

“There are all the different constituencies involved in catastrophe bonds that are already located in Bermuda,” he said “If we have a return [to significant alternative capital use] in six months or two years, we can dust off the tools and get back to issuing them.”

Even if catastrophe bonds and side cars begin to ramp up, questions over the “hot money” of hedge fund and private equity investors will make carriers and other cedents think twice about using the capacity, said Kathleen Faries, vice president of Tokio Millennium Re.

“The question I see from cedents is that ‘it’s great you have these ILS investors that want to offer capital, but are they going to be there after an event’,” she said. “Are they going to stay in the market though the soft cycle as well.”

While Bermuda insurers argue that cat bonds and side cars remain a tool to be used by the reinsurance industry rather than a competitor, there is still significant room for growth which could change the reinsurance cycle.

For example, Cash argued that if another large catastrophic event on par with the September 11th terrorist attacks or Hurricane Katrina were to occur side cars would likely flourish rather than the creation of another reinsurance “class.”

“If we need another new source of capital in the industry I think you will see that raised through side cars,” he said. “That will make it difficult to raise capital by forming new companies.”

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