ILS funds could move towards pandemic risk as reinsurers step back

ILS investors have an opportunity in pandemic risk because reinsurers are wary amid Covid-19, despite the sector still being profitable in 2020, according to Colin Dutkiewicz, global head of life for Aon’s Reinsurance Solutions business.

Casual observers of the life and health market may be surprised to hear that the market for pandemic reinsurance cover, which sprung up in response to Solvency II coming into effect in 2016, has remained profitable this year.

The cover is designed to protect against very unlikely outcomes such as a 1-in-200 year event whereas Covid-19 is more like a 1-in-10 or 1-in-20 year event, Dutkiewicz explained.

“This isn’t actually an extreme mortality event,” he said. “This line of business has been profitable and will be profitable in 2020 for those reinsurers.”

Three types of reinsurer

The executive identifies three categories of reinsurers. The first is the big traditional multiline reinsurers.

“They have this accumulation of the pandemic risk themselves and they actually want to offload this risk, they want to retro it,” he said. “But they do write life insurance quota share reinsurance, so they are taking on normal business that adds to their pandemic load.

But what they also have is a whole bunch of longevity risk, and that is an offsetter.

“So [the pandemic] is not a solvency event for them, it is barely a profit/loss event for them. But they don’t want to load up more of this cover.”

The second category of reinsurers are the slightly smaller reinsurers, such as PartnerRe and QBE, which are happy to write the business and understand it well. “They are very effective at writing it, and they are innovative and are hungry for business,” said Dutkiewicz.

The final category is the ILS funds. “They are always trying to access the life space, and I think they will get going now,” said Dutkiewicz. “This is kind of their time.”

Life insurers did not feel the need to go with an unrated ILS fund when there was sufficient capacity and prices were coming down. “Suddenly capacity reduces, the big traditional reinsurers are reticent and the middle-sized reinsurers which were writing it start cutting back or reducing capacity,” he said.

“The ILS funds can step in and say, ‘We know it is a good risk, we have got the capacity, yes we underwrite it but we can collateralise it.’ So suddenly that side of the market is taking off in terms of capacity provision.”

For ILS funds, pandemic life risk is not correlated with the markets and also offers a diversifier from natural catastrophe cover.

He said a number of reinsurers that have suffered losses on the non-life side from event cancellation and business interruption have stopped writing pandemic on the life side. “Which makes no sense because it is profitable on the life side,” he added.

Models shift to scenario based

Dutkiewicz reported that Covid-19 has not disproved the modelling of pandemic risk. He said Aon’s calibrations were from 1918 Spanish flu, outbreaks in 1956 and 1965, and 2003 Sars.

“The modelling had the reality covered completely,” he said. “The caveat to that though is that what we were doing is the stochastic modelling where we were modelling 10,000 possible outcomes from the horrendous ones to the not so horrendous ones. That worked before you had a pandemic. Once you are in a pandemic, things change. 

“Suddenly capacity reduces, the big traditional reinsurers are reticent and the middlesized reinsurers which were writing it start cutting back or reducing capacity. The ILS funds can step in”

“So the method of modelling has changed from the stochastic modelling of something you thought was going to happen to scenario base modelling of what is happening. Now if you are running an insurance company you have to say: ‘Well, here are five different scenarios of what can happen, I need to make my organisation robust in light of all those scenarios.”

One of the biggest surprises from the reality of the pandemic has been the risk factor of the country involved. The models basically assumed that if a country had a good pandemic plan it was a good risk, and vice versa. “Of course, what has happened is not that,” said Dutkiewicz. “The nations that have got it right and the nations that have got it wrong have been completely surprising.”

Dutkiewicz noted that the biggest issue now from a mortality perspective is not the Covid deaths but issues such as deaths from people who did not go to cancer screening during the pandemic and reductions in health spending under austerity measures in a recession.

He said the modelling “was fit for purpose” but will evolve. “The broad-brush stochastic modelling we were doing on pandemics is going to give way to a much more granular cause of death model,” he said.

“The reinsurance covers have worked as expected – they comprise detailed contracts covering a lot of eventualities, every single one of those eventualities has been completely understood and validated, the reinsurance was written in the right way.”

In terms of reinsurance performance in this area, however, Dutkiewicz said the next few years will present challenges for those in the market.

“It is complicated now,” he said, “but the next three years are even more complicated with actually bigger impacts than what we are seeing this year.

“It is a longer slower burn for life reinsurers than it is for non-life reinsurers who can get out of a line tomorrow. The life market is $180trn of exposure, and no reinsurer can get out of one dime of that exposure next year. So they have a longer term view of this with these more complicated issues going on that they have to figure out.”