Millette: ILS cat paradigm is “broken”; wholesale rethink required

Hurricane Ian is proof the cat reinsurance “paradigm has broken down”, with ILS investors expected to demand a substantial restructuring of both the coverage and collateral triggers before they consider another reload, predicts one of the sector’s most influential voices.

Speaking to The Insurer TV, Mike Millette, co-founder and managing partner at ILS fund manager Hudson Structured Capital Management (HSCM), said there is a “tremendous amount of fatigue” among the ILS investor community as they contemplate the uncertainty of another heavy loss year in the wake of last month’s $50bn+ Florida storm.

“Whether by chance or by change in the world, we’ve now had six years of difficult experience in cat markets – investors have reloaded only to see further losses,” Millette said.

“There is a tremendous amount of fatigue about that … about that reloading mechanism and whether that paradigm of loss, reload, gain, peace and then loss … still holds true.”

Michael Millette

As a consequence, ILS cat investors will insist a “different sort of bargain needs to be struck”.

Millette is regarded as one of the forefathers of the ~$100bn ILS market, having advised on many of the sector’s earliest securitisations in the late 1990s and then post 9/11 during a 21-year Goldman Sachs career, before launching HSCM in 2016 with former Pimco EVP David Andrews.


Cat reinsurance was based on the premise of mostly quiet years of loss activity and occasionally active years, he explained. In this cycle, gains in the subsequent quiet years would make up for the losses in the more active years. 2013-16, for example, were regarded as the quietest years for cat activity for almost 200 years.

But since 2017, cat reinsurers – both rated carriers and ILS funds – have endured a roll-call of heavy loss events which are prompting fears that the models are failing to contemplate the impact of climate change on frequency and severity.

Global insured losses

“That paradigm worked after 9/11, it worked after [hurricanes] Katrina, Rita, Wilma … that paradigm has broken down,” Millette explained in the 15-minute Close Quarter interview on The Insurer TV.

Trapped capital

ILS investors pay an additional price because of the buffer loss tables, which mean cedants have the right to “trap capital”, preventing it from being recycled to underwrite in the following year for a defined period that captures the loss movement.

Noting that Hurricane Ian losses could total $50bn or more, Millette said the phenomenon has re-emerged once again.

“When we talk about trapping, we have a lot less uncertainty. I’m pretty certain that markets are going to want to trap to make sure they have collateral available,” he said.

“They’re going to be trapping at the high end, which will mean that a great deal of the whole capital markets complex, whether it’s bonds or collateralised reinsurance, will be trapped for some time,” Millette added.

He would not be drawn on how much ILS capital will be trapped but predicted it will lead to a wholesale reappraisal of the concept, noting that in the past there was a cost associated with triggering collateral.

“I do expect that, for investor capital to come back in, there is going to be much heavier pricing on trapped capital to demotivate trapping unless it’s absolutely necessary,” Millette noted.

He explained that “in the early days” of ILS, trapping could cost 50 percent of the rate on line and thereby acted “vaguely like a reinstatement premium” before fiercer competition saw that whittled away.


“It was expensive to trap capital and that wore away over time. We’re going to see a revival,” he predicted.

He also anticipates that, in addition to pricing, cat capital will now insist on a greater focus on the likelihood of loss and much higher limits, while also properly taking into account factors such as inflation.

“We’re going to have to re-baseline some of these cat losses … and then make sure that we’ve modelled all layers of inflation. That’s demand surge, economic inflation and social inflation. Once you do that, then you have a new expected loss, and then you can set a price,” Millette explained.

This means there will be more substantial price changes than there have been in the last few years “as you go up and down the ILW structure”, he said, adding this will put upward pressure on premiums in the primary market to account for higher reinsurance costs.

“There will be investment capital, we think, that will come back into the market. But we’re not sure exactly when exactly at what price and exactly on what terms,” he concluded.

In the latest 15-minute Close Quarter interview, Millette examines:

-          ILS capital: what changes it will demand

-          The impact of trapped capital

-          1.1 & 1.6: how they are connected

-          2023 retro market

-          Prospects for a cyber 144A cat bond