COVID-19Virtual Roundtable

ISSUE 7: Leaders’ commentary on latest crisis developments 12-15 May 2020

Supported by

In this edition:c How is Covid-19 impacting collateralised re?c Will trapped capital impact midyear renewals?c What questions are investors asking about Covid-19?c Will Q1 delays cause Q2 ILS to be scaled down or downsized?c Is there interest in pandemic bonds?

There is a lot riding on whether claims emanating from the Covid-19 crisis

filter through to the insurance-linked securities market.

Confidence in the sector would suffer significantly if claims from an unmodelled, and not-thought-to-be-covered, peril such as a pandemic triggers losses.

The market has had one too many instances of that already. A brief reflection on recent history brings the California wildfires starkly into focus and the significant, and not accounted for, loss creep that accompanied events such as Hurricane Irma and Typhoon Jebi that led to three consecutive years of trapped collateral for ILS funds.

A withdrawal of investor interest would have significant implications across the (re)insurance industry at a time when pricing is already increasing. A cutting back of cat reinsurance capacity would add further fuel to the rate rise fire.

The second quarter and the lead up to the midyear renewal was always going to be a busy time for the ILS market, with Aon highlighting last month that some $4.1bn of issuance was set to mature during the period. Issuance that was pushed back from Q1 has only made Q2 busier, leading to concerns that Covid-19 related financial upheaval will mean there is insufficient

investor support for deals that might have to be restructured or downsized altogether.

But, participants in our latest Covid-19 Roundtable explained, capacity for cat bonds remains steady. Consequently, the expectation is cat bonds that come to market, including those delayed from Q1, will get completed, although with investors seeking a higher expected return, the cost will be at the upper end of pricing ranges.

There is, however, talk of a capacity crunch in the collateralised reinsurance market, with writers adopting a wait and see approach earlier in the midyear renewal amid concerns of collateral being locked up from potential Covid-19 losses.

At the same time, investors may begin to look at opportunities

elsewhere given Covid-19’s impact on the equities markets.

One thing is for certain: once the dust settles on the renewals, there remains plenty to discuss.

How can ILS structures ensure they are watertight for pandemics? More than ever investors will want to know with absolute certainty what is, and what is not, in portfolios of risk they invest in.

Out of adversity frequently comes opportunity though, and, provided investors are comfortable with the modelling, there is renewed talk of new alternative risk transfer solutions for pandemics coming to market, as well as the potential growth of the pandemic bond market. Is this perhaps a bright new future for the market?

I hope you enjoy this week’s roundtable – it is certainly an informative read.

A withdrawal of investor interest would have

significant implications across the (re)insurance industry at a time when

pricing is already increasing

THIS WEEK’S PARTICIPANTS

2 | COMMENT | 12-15 May 2020

Quentin Perrot,Senior Vice President,

Willis Re Securities

Paul Schultz, CEO, Aon Securities

Dirk Lohmann, Head of ILS, Schroder

Sequaero

Michael Halsband, Partner, McDermott Will

& Emery

The ILS Covid-19 test

Luca Albertini, CEO and Founding

Partner, Leadenhall Capital Partners

Christopher Munro Associate Editor

COVID-19 ROUNDTABLE | 12-15 May 2020| 3

What impact is Covid-19 having on the collateralised reinsurance market?

Luca Albertini: Covid-19 has adversely impacted the overall reinsurance markets in a number of

ways, with available capital to be affected by a combination of insured losses and losses in the investment portfolios. This general trend will sustain the current trend of hardening for both pricing and terms and conditions. The collateralised market is generally not affected by losses in the collateral investments (as collateral is generally invested in risk free assets) but has seen some redemptions some of which is motivated by liquidity needs and in other cases motivated by the need to maintain the allocation to ILS within a given range (with ILS holding their value but other investments seeing material losses, ILS have increased as a proportion of some investment portfolios). Once again, a further reduction of capital available to collateralised reinsurance will sustain pricing and terms and conditions.

Dirk Lohmann: Up to now we have seen limited impact on current renewals, other than price

increases. Here the question is whether the increases can actually be ascribed to Covid-19? I would venture to say only to a limited extent as the pricing corrections in many instances were already anticipated prior to the outbreak of the pandemic.

Obviously, there is the discussion about a specific exclusion for communicable disease and this is generally being accepted, although

some cedants are arguing that their business mix and underlying exposures do not warrant an exclusion. So far, we have not experienced any situations where collateral has been trapped on April 1 and May 1 renewals. I also doubt that we will see much of this for June 1 collateralised reinsurance since most of the business being renewed is catastrophe protections covering personal lines and residential property business.

Trapped collateral may be a topic for covers protecting large commercial property or E&S writers or aggregate protections, but here our exposure to such programmes is limited to non-existent. The answer to that question will have to wait until year-end when the programmes renew. We may also see an elevated loss ratio under certain quota share or side car arrangements, but this doesn’t automatically mean that collateral will be trapped, just that returns on such contracts may be reduced somewhat.

Quentin Perrot: Covid-19 will impact those collateralised reinsurance policies that are “all perils”

as opposed to “named perils”. In that case, the cedant may be able to claim for a Covid-19 BI loss. The current uncertainty is two-fold: 1) in

A further reduction of capital available to collateralised

reinsurance will sustain pricing and terms and conditions

Luca Albertini

case of a loss from the cedant, how much of it will go through to the particular collateralised reinsurance layer? This is not so easy as most cedants currently have limited visibility on what this loss could be. The situation could differ country by country and there is also the issue of the event determination (What is the event start date? How do you apply the hour clause? Etc…)

And 2) because of this uncertainty, the cedant may decide to trap the collateral at the next renewal, even if it is subsequently determined that the collateralised reinsurance layer is not affected. In particular for the 1.6 renewal, which is very near us now, there will be a strong incentive for the cedant to trap the collateral since, in many instances, it is simply too early to know what the loss potential could be. As most collateralised reinsurers are working on the assumption that their collateral will be rolled-over, this could make it difficult for them to “re-load”, in particular if their end investors do not want to give them additional capital. But fortunately, a number of investors have been able to raise capital ahead of the emergence of Covid-19 and should be able to participate nonetheless.

Will we see trapped collateral and how will that affect mid-year renewals?

Luca Albertini: In our case, the lion’s share of the mid-year renewals are predominantly residential

and to date we have not been asked for collateral trapping by our counterparties. In my view the first significant test will be at year end

Luca Albertini: Investors are indeed asking many intelligent questions about Covid-19 and at Leadenhall

we have about half of our capital invested in life insurance linked opportunities, and so this event is relevant for all of our portfolios. For us a detailed understanding from investors is key for their resilience in the asset class. In terms of their

appetite the general feeling is that there is the potential to deploy at improved terms in non-life and life insurance linked securities after having proven, like in 2008 the low correlation with the equity and the credit market. What can spook investors is very conservative collateral trapping and “social inflation” where litigation causes material losses where there was no coverage. The industry is very strong in holding its line on these points and we feel it is not in anyone's long-term interest for social inflation to prevail: as we saw in Florida ultimately the governments will legislate to curb abuse and create clarity where needed.

4 | COVID-19 ROUNDTABLE |12-15 May 2020

when a large proportion of retrocession and some large commercial programmes are renewing. Whilst today there still is some uncertainty on the loss outcome for the industry (and let’s not forget that the event is still on-going), we believe that in six months’ time it will be easier for the market to assess the loss outcome for business interruption. Protection buyers will need to balance very conservative reserving needed to hold collateral, with the real possibility that not all trapped collateral can be replaced with fresh unencumbered capital at attractive terms.

What questions are ILS investors asking about Covid-19 exposures for the insurance industry and how will it affect their appetite for risk going forward?

Paul Schultz: On the sidecar side, the questions that we are receiving are generally surrounding how

Covid-19 is classified by insurers and how it will affect their commercial policies. On the bond side, questions are limited to cat bonds containing ANP and “Other Perils” with a closer focus on bonds with commercial coverage. Investors are wondering if these bonds have any exposure to the pandemic given the uncertainty if the pandemic will be qualified as a “Natural Risk”. There could be some exposure but it should be fairly limited given the strict definitions within the bond market. Investors have already begun to ask for even stricter exclusionary language.

Should the collateralised market suffer severe or even

modest impairments from BI loss creep, this could be a severe blow in terms of

attractiveness and investor interest is likely to weaken

Dirk Lohmann

Dirk Lohmann: To be quite frank, after the disappointments of 2017 and 2018 ILS investors have

absolutely no appetite for further unmodelled risk. They are concerned and asking their managers a lot of questions about potential exposure from non-damage or contingent business interruption. In addition, they are asking managers to provide detailed assessments of the portfolio composition and assessments as to which contracts have significant BI exposure. This asset class was sold to investors as non-correlating headline tail risk. Covid-19 certainly is a headline event, but it was not expected by investors nor is it non-correlating. Should the collateralised market suffer severe or even modest impairments from BI loss creep, this could be a severe blow in terms of attractiveness and investor interest is likely to weaken.

Quentin Perrot: At this stage, the question is simply to find out whether the cedants are even

exposed to this peril and, if so, if they are able to provide a view on possible loss exposure. Once this is figured out, parties will certainly look at the specificities of their reinsurance contract to determine the exact loss amount attributable to them.

We are already seeing for the upcoming renewal, reinsurers (ILS or traditional) providing lines subject to clear exclusion of future pandemics. As with any large unexpected loss event, the industry will learn its lessons to make sure that the current uncertainty is mitigated going forward. In our case, this certainly means tightening up the wording to better define exclusions

Dirk Lohmann: When looking at aggregate cat bonds I think you have to differentiate between

those that are based off of PCS or PERILS indexes and those covering primary insurance companies on an indemnity basis. The indexed based covers can still find support, albeit at higher spreads than in the past. Less enthusiasm – at least within Schroder Secquaero, but probably for other managers – exists for indemnity-based triggers covering a broad range of perils, including wildfire, flood, winter and severe convective storms. Here past-experience has shown that the actual performance deviates substantially from the model projections. Our own analysis of such covers has shown that there is a significant degree of model risk for those perils and that the degree of exposure posed by them is significant. As a consequence, we prefer to pass on such bonds and focus more on the occurrence instruments for such sponsors.

Issuance delayed earlier in the year is now rushing to get done. Will the surge cause some ILS to be scaled back and downsized? Will some have layers removed?

Dirk Lohmann: It is true and also encouraging to see a number of new issues coming to the

market. It is also true that certain deals were pulled or postponed in mid to late March due either to a lack of support for the sponsor or to the pricing levels offered, as well as a short-term

and loss calculation principles for future pandemics.

How is investor demand for aggregate v occurrence cat bonds and what is driving dynamics?

Quentin Perrot: So far, it would appear that cat bonds have fared better than the rest of the ILS

industry. Because the vast majority of the cat bonds operate on a “named peril” basis, which does not include any pandemics, the market currently assumes that any direct loss for Covid-19 will remain limited. Investors are telling us that they have not seen any meaningful redemption as a consequence of the financial crisis and the historically high redemption schedule of Q2 2020 will provide investors with liquidity that they can reinvest in new cat bond issuance. We are already seeing new cat bonds being placed, such as Scor’s Atlas 2020 or Swiss Re’s Matterhorn 2020-3 with a few others currently in the market.

That being said, the trend toward tighter structures that had begun before Covid-19 will certainly not disappear and we anticipate continued investors’ discipline going forward. In that context, it is likely that investors will keep buying aggregate cat bonds, but only for named perils and with a spread mark-up against occurrence structures.

Paul Schultz: Over the past few months, we have seen a deviation in price for per occurrence and aggregate

transactions, and demand remains for both among the investor community.

COVID-19 ROUNDTABLE | 12-15 May 2020| 5

capacity squeeze due to flow-related selling pressure in the secondary market.

Given that a number of bonds have either matured in April or are scheduled to mature in May, we always expected the pipeline to reopen and the recent flurry of new issuance mostly by existing sponsors is confirmation of that. At Schroder Secquaero we kept our liquidity levels high coming into the spring so that we could continue to provide significant capacity and act as an anchor investor if the bond conditions correspond

to our KPIs. The sizing is in part also a function of market price levels and budgetary constraints at certain sponsors. Spreads are clearly up and as a consequence the amount of limit that can be purchased may be constrained. For those not constrained by budgetary concerns, there is capacity and supply available, but perhaps not at the levels seen a few years ago. The basic issue is that there is presently only a limited amount of new money flowing into the bond sector despite the very attractive spreads. Our experience has been that most of our clients in bond mandates are quite happy with the performance, especially relative to other asset classes, but are unable to increase

Over the past few months, we have seen a deviation in price for per occurrence and aggregate transactions, and demand remains for both

among the investor communityPaul Schultz

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their allocations due to the increased weight of their ILS position thanks to its stronger relative performance.

Luca Albertini: The ultimate size of new issuance will depend on capital inflow in the traded

cat bond market. This market remains attractive to investors, had limited mark-to-market losses as it has been and is less impacted by social inflation so I believe ultimately capital will return to cat bond funds relatively soon. On the demand for cover side I remember the original pitch when

I was on the origination side at the beginning of the century: cat bonds provide collateralised cover but also diversifies the sources of capital. The latter benefit is quite prominent these days with the current uncertainties around the available reinsurance capital.

If I was a buyer in the retrocession market I would want to ensure I can get some capacity in the cat bond market albeit with basis risk before the January renewals.

and continuous and we would anticipate there to be demand but we do not give forward looking statements.

Has there been any new interest in pandemic bonds from sponsors? Are investors interested? Do you expect to see a swell of interest in them given current events? If so, from what sectors?

Michael Halsband: No surprise, the pandemic wrought by Covid-19 revealed a significant risk

transfer protection gap. For the most part, the reinsurance and insurance market has all but shut down prospective coverage for this risk. Despite apparent good intentions, governments worldwide will be slow to address that gap. If and when they come together, government solutions will be less refined blunt instruments by their nature. Much as we witnessed institutional investors create capacity in extant wildfire risk – trading on a private basis in subrogation rights and offering new capacity – we are exploring with our clients alternative risk transfer solutions. Given the complexity and esoteric nature of the risk, it is more likely these initial trades will be undertaken on bilateral and bespoke basis, rather than in bond form.

Paul Schultz: There has been chatter but nothing concrete at the moment. Investors could be

interested but it would be price and structure dependent.

Michael Halsband: We do not expect the hesitation that appeared earlier this year to negatively impact

the ILS market long term, nor will it result in any significant scaling back of transaction activity or investor interest. The ILS market has long operated distinct from the broader credit markets. The investor base is well established and continues to focus on the non-correlated nature of the class. The capacity dedicated to the ILS market has held steady. Recent years’ trapped capital is more likely to contribute to contraction than anything else. Expansive opportunities to fill protection gaps – if traditional markets contract, as seems may the case in some areas – will create additional ILS opportunities.

Quentin Perrot: Those cedants that use cat bonds for strategic reasons, with well-defined long-term

objectives, will remain faithful to the cat bond market. Investors have proven so far to be resilient and the fundamental value of a cat bond in a broader reinsurance program is therefore re-evidenced. Obviously, the lockdown does not help, with teams having to work remotely on these projects at a time when they also have to manage the consequence of Covid-19 and a financial crisis. Hopefully, investors will be sensitive to this situation and support cedants appropriately when they come to market.

Paul Schultz: We do not believe that issuance was delayed as we have seen a steady pace of new

offerings with minimal exceptions. Issuance has been robust

Much as we witnessed institutional investors create

capacity in extant wildfire risk – trading on a private basis in subrogation rights and offering new capacity

– we are exploring with our clients alternative risk

transfer solutionsMichael Halsband

should have appeal over bilateral collateralised reinsurance. From a cedant’s perspective, in a hard market, it becomes increasingly valuable to diversify capacity by bringing in more ILS investors. By providing a syndicate, the cedant still obtains better price discovery. Private placements, given their smaller deal sizes, can have multiple classes across various parts of a tower. Moreover, private placement cat bonds open up the ILS market to a greater range of cedants, including regional and super-regional cedants. As we move into a harder market, private placement cat bonds should grow and offer a nice complement to traditional cat bond issuance.

Quentin Perrot: The main benefit of a private cat bond is to reduce the setup costs compared with a 144a

issuance. So in practice, this is really helpful for those cedants who want to buy more than what the ILW market can offer but not so much that they can afford a 144a cat bond. This still means a large panel of potential cedants and we do anticipate more interest, in particular in the retro space, as the cat bond investors still have capacity to deploy. But it is important to remember that the cat bond investors will want to work on their own terms: simply packaging a UNL retro cover into a security will not be acceptable to most of them.

Michael Halsband: Broadly subscribed 144a issuances and collateralised reinsurance will continue to

hold sway in that part of the ILS risk transfer market they’ve dominated for years – natural catastrophe, commoditised, elemental risk. The exploration of pandemic risk transfer and other novel exposures,

however, will require bespoke solutions. Key features of such transactions will include parametric triggers, bespoke bilateral transactions, innovative, efficient and prompt recoveries and operational leverage.

How is pricing looking in the ILW market and what role will the product play at 1.6/1.7?

Dirk Lohmann: We are seeing an increased number of inquiries for ILWs and offered prices are

definitely up over prior years. Having said that, many of the inquiries are for All Natural Perils protection and often on an aggregate basis, which is not something that finds a lot of interest amongst sellers who prefer named perils only. We have also observed that there appears to be quite a divergence between pricing expectations from buyers versus those of the sellers, so while there are a lot of inquiries, it’s not that clear as to how much is actually getting done. We expect the activity to increase as we approach or come through the June 1 renewals.

Quentin Perrot: The ILW market is definitely open for business and remains a competitive alternative to

retro cedants over UNL retro, for those cedants who are willing to assume the basis risk of an index product. The ILW market is easy and fast to access as there is no structuring work required. However, there is a finite amount of capacity available, in particular for tailor made triggers. For larger sizes, the best alternative becomes the cat bond product, whether private or in 144a form.

Quentin Perrot: Right now, buying a pandemic cover is like purchasing a US hurricane cover the day it

makes landfall. There is great uncertainty on the risk and finding a suitable clearing price for both cedants and investors will be challenging.

As the pandemic subdues, cedants – whether life insurers or corporates trying to cover their BI exposure – will try to use this event to better inform their own exposure and tolerance to the risk – as well as their budget for covers. Pandemics cat bonds may then be an option. But the same is true for investors: most of them have capital but the view of the risk is unclear. To that effect, the view of the modelling agencies on the risk will be very useful, once that is available.

What are the advantages of private cat bonds over 144a issues in this environment and will we see greater demand for cat bond lites and other solutions to fill in gaps in cat programmes as the traditional market hardens?

Paul Schultz: We don’t see outright advantages of private cat bonds over 144a but there may be

some advantages over other ILS products. Private placement cat bonds are part of the continuum between bilateral collateralised reinsurance and traditional cat bonds. Private placement cat bonds are tradable among much of the ILS universe (depending on the platform). As upstream investors want more liquidity, private placement cat bonds

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