17 // THE DISASTER GAP: HOW INSURERS AND THE CAPITAL MARKETS CAN HARNESS BIG DATA TO CLOSE THE GAP
4. CLOSING THE GAP
Despite the barriers presented by a lack of historical data and models for certain perils, many experts think the next generation of cat bonds will broaden their scope to cover classes of business outside property catastrophe. After all, traditional reinsurers and retrocessionaires have deployed a sophisticated approach to underwriting risk management for a wide range of classes and specialist risks. Such an approach, combined with better exploitation of big data, should aid cat bond innovation in the future.
To date, some cat bond transactions have occurred for mortality and longevity risk, while this year’s Tradewynd deal and much earlier Avalon Re cat bond have securitised energy liability risks. Other cat bonds have been used for motor insurance, terrorism and workers’ compensation risk transfer. Aviation cat bonds have also been mooted.
However, it is unclear how future bonds will be structured for some of these new classes and whether investors would have the appetite for longer-tail risks. “Before you can move into these areas you need a robust modelling structure that can look back over historical data as well so that when putting some of these structures together you know how to price them,” says Wilkes.
Assuming current barriers can be overcome there is great potential for cat bonds to expand. The difficulty is coming up with accurate predictive data to reflect the potential size of the market in the next few years. Willis Re is bullish about the market’s potential, predicting $100bn in alternative capital will enter the reinsurance business over the next three to four years, transforming the industry in the process.
Other experts take a more cautious view. They question how “sticky” the new money entering the sector really is and what will happen if interest rates go up or if there is a major catastrophe event. Munich Re’s Dr Müller predicts that for the foreseeable future alternative capacity will remain within the commoditised space like natural catastrophe excess-of-loss.
For Artemis’ Evans, ILS investors are here to stay. “I talk to the pension funds and ILS managers on a weekly basis and they are adamant that the money is going to stick around,” he says. “They have no interest in coming into this space just speculatively – they’re not just seeing an opportunity for short-term yield – and in fact if they had done they would have pulled their money back out because yields have dropped so much.”
The big brokers are each predicting that convergence capital is here to stay and that it is likely to grow substantially over the next five years or so. Predicting the potential for ILS growth requires that you consider the growth in investors, growth in issuers and impediments to the asset class and writing of risk in emerging economies.
As it relates to the growth in investors we see four key drivers behind the convergence of the reinsurance and capital markets:
– direct investment into insurance; – returns over libor; – uncorrelated asset class; and – risk diversification.
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