ILS Capital has raised $57mn from a securitisation of trapped reinsurance assets, a first-of-its-kind transaction that could pave the way for future deals to unlock an estimated $15bn of trapped capital across the industry.
ILS Capital managing partner Tom Libassi said the transaction could help resolve an issue that has vexed the alternative reinsurance industry since the losses related to the natural disasters of 2017 and 2018.
"By unlocking capital that would otherwise be kept from being redeployed, this transaction gets money back into the hands of our investors more quickly, making it available for new investments while still providing our investors with potential upside.”
The securitisation covered 51 reinsurance contracts exposed to 18 catastrophe events that have occurred in the past three years. It will free up 70% of ILS Capital's total trapped capital at the start of 2020.
Some of the proceeds will be returned to investors that have redeemed in the past year, but ILS Capital said the vast majority would be retained by the fund and redeployed.
The Bermudian asset manager will pay investors a 5.5% coupon on the transaction.
Investors from global and regional asset managers and insurance companies participated in the deal, which was marketed by BNP Paribas’ debt private placements and asset-backed securities syndicate desks, and offered by a subsidiary of the ILS manager, Parliament Street Finance.
How it works
The securitisation enabled ILS Capital to monetise the residual value of the contracts at a lower cost than other alternatives, preserving potential upside from reserve releases for the fund investors and making it possible for the fund to redeploy the capital into new investments, Libassi explained.
The ILS firm gives up the coupon income going to debt investors, but if it makes more than a 5.5% return from redeploying cash in fresh underwriting assets then it stands to gain overall.
The securitisation involved Parliament Street taking over an interest in all of ILS Capital's trapped capital, bundling up a share for investors in the debt notes.
The underlying collateral remains in trust funds for the ultimate cedants and, as this capital is released, this will provide the financing for the coupon and principal repayment. While the securities have a final possible maturity of five years, ILS Capital expects the debt to have an average life of less than two years.
Parliament Street has a large equity cushion equal to approximately 30% of the trapped capital, and if the cash ultimately released from the underlying contracts falls short of the base projections, this equity buffer would be used to repay debt investors before any potential default.
Libassi said that the 30% equity buffer layer was higher than the typical levels of security built into traditional asset-backed securities of a similar rating. The rating level on the private deal cannot be disclosed.
Securitisations have not formed a major topic of industry chatter around potential fixes for trapped capital. Other solutions that have been discussed include legacy transactions or bank financing.
But at a panel earlier this year, speakers said that banks were generally wary of taking on insurance reserving risk and that financing was not available in enough volume to help address the issue in a significant way; while confidentiality and competition concerns were holding back ILS managers from trading out of positions with other managers.
Libassi told Trading Risk that the reinsurance and legacy market had simply not been able to come up with solutions that could work.
"Everyone has tried to find a reinsurance solution to what is an investment issue, and that's been the problem," he said.
Legacy providers wanted the underlying assets to invest and deals would require ILS managers to give up the upside of reserving risk, he explained. Meanwhile, reinsurers were not willing to front up cash in exchange for the future income from assuming risk.
Obtaining a rating for the debt was also crucial to providing proof of concept for investors and an independent take on valuation risk. Getting the "brand new asset securitisation" off the ground took less than two months overall, Libassi added.
ILS Capital is also among the firms that are moving to set up rated balance sheets, with Kroll Bond Rating Agency giving the firm's Prospero Re an A rating earlier this year on the basis of a planned shift in business model.
This will see investors in the firm's 1609 Fund take equity positions in Prospero Re, allowing the company to minimise trapped capital, or at least to manage decisions over how much capital to hold back internally rather than with external cedants and fronting providers, as the firm told Trading Risk earlier this year.
On the new $57mn debt securitisation, Goodwin Procter and ASW Law served as legal advisers to ILS Capital. Mayer Brown provided legal counsel to the investors in the transaction.