Insurance-linked securities marry insurers in search of capital with investors in search of risk to cover. Guernsey’s long history of innovation in this area has rewarded the island with a thriving market in the investment instrument
As a thriving centre of investment and insurance in the Channel Islands, Guernsey continues to drive innovation across the two sectors. Its latest achievement on this front are investment instruments known as insurance-linked securities (ILS).
These increasingly popular investments allow insurers to offload risk and secure capital, while offering investors a diverse portfolio by adding investments that are uncorrelated to economic or geopolitical events.
This means that they are not linked to anything except the insurance for which they have been created – for example, a catastrophe bond covering one specific or a selection of specific potential catastrophes.
Guernsey has been responsible for several world firsts in the ILS market, including a hybrid vehicle that allows one entity to act as both insurer and investor, and the first listing of notes digitised on a blockchain.
“The ILS industry emerged in the early part of the century, mainly with sidecars and cat bonds in Bermuda, because these offered a very efficient way of raising capital for the inexhaustible natural catastrophe market in the US,” explains Dominic Wheatley, Chief Executive of Guernsey Finance.
Collateralised reinsurance
“In 2006, collateralised reinsurance came along, offering a different way of achieving the same result,” adds Wheatley. “However, this was a slow burner and it took some years to gain the confidence of investors.”
Collateralised reinsurance allows investors to pay collateral into the policy, where it remains until the end of the reinsurance term, when it can be returned. This means the risk is always fully collateralised should it need to cover losses.
There were concerns in the reinsurance industry around investors remaining in the market following a large loss. However, in 2017, when global insured losses from disaster events reached $144bn, with hurricanes Harvey, Irma and Maria resulting in combined insured losses of $92bn alone, investors took the hit.
“They simply ‘re-loaded’, meaning they accepted the loss and invested in the market again,” explains Wheatley.
Today, the ILS market is thriving. “Where risk had historically sought capital, the attraction of ILS as an investment has seen capital looking for risk to cover,” says Richard Sharp, a Partner at law firm Bedell Cristin.
Guernsey offering
Several factors have contributed to Guernsey’s position as a leading centre for ILS – a concentration of expertise among its insurance managers and other professional advisers, and its investor-friendly regulation, efficiency and structural superiority.
“Guernsey has a long history of innovation in the ILS space, starting with the creation of the world’s first protected cell company (PCC) by Aon Insurance Managers (Guernsey),” says Mark Elliott, Director of ILS Management within Aon’s Captive and Insurance Management division.
A PCC is an investment structure that essentially has a ‘core’ surrounded by separate cells. Both the assets and liabilities of one cell are segregated and protected from those of the other cells. This prevents all of the assets of the PCC from being exposed, instead limiting liability to a specified contract and pool of assets.
In addition, Guernsey offers a range of benefits that are not available from other jurisdictions.
“The grace periods permitted under the Guernsey Special Purpose Insurer Rules have been a real boon for Guernsey,” explains Sharp. “These rules allow 30-day periods before collateral needs to be applied, both at the time of formation and also in the intervening period between one risk ending and a new risk being written. This removes the time lag otherwise inherent while collateral is freed up and then reapplied.”
Guernsey also accepts Letters of Credit (LoCs) as methods of collateral.
Change of competition
Historically, Bermuda has always been Guernsey’s main source of competition, but now that London is opening its doors as an ILS jurisdiction, it has raised the question of whether these two regions will be in competition.
“While there will always be a proportion of transactions that will take place in London, the region is a very new player to this space and would struggle with the bulk, so we don’t view London as a competitor,” explains Wheatley. “In fact, if London were not the global centre that it is, Guernsey wouldn’t be where it is today. Our proximity to London is certainly an appealing factor to our EU investors.”
Christopher Anderson, Partner at law firm Carey Olsen, adds: “London’s ILS structure is based on Guernsey’s PCC legacy, which is a testament to its robustness. We have been an ILS jurisdiction for around 20 years, and for London – arguably the leading re/insurance market in the world – to copy our set-up, it must mean we’re doing a pretty good job.”
TISE landmarks
The International Stock Exchange (TISE), which is located in Guernsey, is able to meet an extremely wide range of the capital market needs of the global reinsurance community, which is why it has listed so many landmarks in the ILS sector.
“We’ve been listing ILS since 2010/11,” says Fiona Le Poidevin, CEO of TISE. “We listed the world’s first private catastrophe bond, Solidum Re Eiger. We also listed the first securitisation of takaful (Sharia-compliant) insurance policies.”
As mentioned earlier, in 2018 Guernsey also became home to the first listing of notes digitised on a blockchain, which greatly reduces transaction costs in an ILS deal. Blockchain refers to a digital set of records that is decentralised, so no single person or entity holds them.
“Increasingly, cost and time to market are becoming more important and Guernsey offers an easy set-up for institutional investors – especially since the introduction of the hybrid vehicle,” explains Le Poidevin.
This hybrid vehicle, launched in March, allows one entity to act as both a manager and an insurer, removing the need for fund managers to ‘rent’ cells in order to enter into transactions.
“The hybrid allows managers to deploy the money that they’ve raised without having to go through another jurisdiction, which avoids duplicating processes in order to comply with legislation in each region,” says Carey Olsen’s Anderson.
“It’s already creating interest – primarily in the US – and is likely to further highlight Guernsey as a jurisdiction and demonstrate its ability to innovate.”
Future-ready
The finance sector is experiencing a significant demand for ‘green’ initiatives that focus on sustaining the environment. TISE GREEN – a market segment of TISE – is dedicated to listing securities that create a positive environmental impact through green and sustainable finance.
“TISE GREEN features ILS, cat bonds and other securities listings – mainly insuring severe weather events – which enable insurers to provide disaster relief,” says Le Poidevin. “Ultimately, this leads to an increase in the ability to combat climate change, which ILS is working to address.
“There is also a social impact as disaster relief helps people who have lost their homes to severe weather damage.”
Le Poidevin believes that there is an opportunity for Guernsey to attract more such ‘green’ business, contributing to efforts to make the planet more resilient.
“Increasing the visibility of these investments through TISE GREEN should encourage even more capital allocation to green and sustainable initiatives,” she says.
No signs of slowing
With plenty of fund managers keen to include ILS in their portfolio, the sector shows no signs of slowing. In fact, it is rapidly expanding into other asset classes.
Bedell Cristin’s Sharp, who says that Guernsey will continue to develop products that converge investment and insurance structures, suggests that cyber will be another area of growth.
In addition, the life insurance market is attracting a lot of interest from ILS. “Life represents the most likely growth prospect for ILS funds, and Guernsey has a long history of helping to structure and manage life transactions,” says Elliott from Aon. “ILS funds are also backing managing general agents (MGAs) – in order to get closer to the risk and to diversify their exposures away from pure natural catastrophe risks.”
Le Poidevin concludes: “Available capital is increasing year-on-year in the ILS world, so there’s plenty of the pie to be shared.”