Peter Dunlop, a partner at Walkers Bermuda, reflects on Bermuda’s position at the forefront of the global (re)insurance industry’s evolution with the island’s innovative ILS market continuing to grow and new products and platforms being developed to support ESG and manage emerging risks.

Pete Dunlop Walkers Bermuda

What has been learned from the trapped capital issues that have plagued the collateralised re segment?

The collateralised reinsurer model remains a popular vehicle for risk transfer and diversified investment returns, and we are seeing strong continuing interest from clients in formations of new special purpose insurers/sidecars and Bermuda’s hybrid collateralised insurer class.

Collateralised insurance is not badly dented by trapped collateral issues. It is true that multiple loss years since 2018 have tested the model, and some ILS funds and collateralised insurers have fallen away or pulled back, especially in aggregate retro. But, collateralised insurance remains low-expense, low-friction and capital-efficient with minimal disputes.

The estimated $15bn to $20bn of trapped collateral in a $540bn dedicated reinsurance market is a relatively small percentage, and I think we have to admit that some problems arising in the collateralised model are of our own making or have been imponderable.

Some ILS funds or collateralised insurers did a poor job of explaining insurance’s inherent risks to investors. Some lazy lawyering has led to sidecars having the same board members as the insurer they sit alongside, causing governance and investor-relations problems.

Poorly drafted reinsurance contracts have given rise to uncertainties around claw back, and industry loss warranties’ reliance on unofficial sources of industry loss reporting has caused disputes. Covid non-physical damage business interruption (BI) has caused such consternation among cedants, reinsurers and collateralised re investors that problems were unavoidable.

One unfortunate consequence of the trapped collateral conundrum, compounded by Covid BI uncertainty, is the spike in disputes.

We anticipate being busy these next 24 months on significant collateralised reinsurance and derivatives disputes in Bermuda, which is a natural reflection of the loss activity and contraction in affordable retro coverage. Good news for lawyers, but not the best use of client and investor resources.

But, from my dealings with clients, a market-wide solution for trapped collateral is not far off. All of this is only a further credit to the sophisticated and smart people working in the collateralised segment.

What opportunities lie ahead for the broader ILS space?

We are seeing lots of interest in ILS from life/long-term insurance markets, for which the collateralised model is bound to provide an efficient capital solution.

In climate risk, numerous new ILS products are helping investors and insurers meet their ESG goals. We at Walkers are seeing several new mono-line insurers offering specialised products otherwise not readily available in the market – in cyber, regulatory capital and credit, casualty or California wildfire risk.

Peter Dunlop PQ1

Cyber has long been touted as the next line of business for ILS transformation. I’m sure that will happen one day, and we must take account of the inevitable march of crypto-assets into our daily lives.

But today I do not see how underwriters can analyse and model affirmative cyber coverage risk in the way that ILS investors would need to become comfortable with that line of business.

Healthcare, airlines and IT companies have been hit by large losses in seemingly unpredictable ways by professional criminals and irresponsible amateurs, and we are now seeing hacktivists make their point via cyber attacks in the climate risk area, such as the Adani mine in Australia.

For ILS to work there needs to be strong analytics in place and real contractual certainty around when the investors will be repaid, and on what basis. Cyber raises too many questions at this stage.

ESG has grown in prominence in recent years. How can the ILS market tap into ESG considerations and use them to its benefit?

Insurers – traditional and in ILS – are motivated to take the initiative in pushing the ESG agenda.

That includes appointing senior executive positions for sustainability/ESG with responsibility for driving executive accountability for globally coordinated governance, avoidance of insurance activities that cause environmental harm, avoidance of investment in non-ESG compliant sectors and, importantly, the reputational harm caused by greenwashing.

Advertisement of ESG credentials will increasingly be pushed to win personal lines customers. Bermuda insurers are retaining ESG-specialised management consultants, like Oxbow Partners, to advise them on development of an ESG management mandate and their internal and external ESG data and analytics proposition.

Specifically relevant to ILS, with $51.1bn of net new money being invested into ESG funds in 2020, ILS investors are pushing their own ESG agenda and demanding that insurers find areas of risk that fit a climate risk amelioration goal.

Companies are facing pressure from stakeholders to not only implement short-term carbon offsetting schemes in reforestation, methane capture at landfills, wastewater treatment facilities and investing in energy efficiency technology, but also longer-term means of reaching the net-zero goal of COP26.

With the disastrous situation in Ukraine and the volatility in oil prices, the falling cost of renewable energy sources like wind and solar means that as we head into Q2 2022, there is a real, meaningful argument to transition from fossil fuels to renewables.

Focusing on ESG investors in Asia and emerging markets will assist the developed world with continuing to negotiate pledges from the Chinese and Indian governments to reduce investment in coal-fuelled power plants, as well as co-operating to limit global temperature rises to 1.5°C above pre-industrial levels.

Peter Dunlop PQ2

In terms of climate risk amelioration, it is a joint societal effort we must all participate in.

The business community cannot leave it to governments to tackle the climate risk crisis. In turn, some governments already provide tax credits for developing low-income housing projects, renewable wind and solar projects and other ESG-focused initiatives.

What are you seeing in Bermuda to support ESG?

Dedicated ESG and net-zero carbon emissions ILS funds are appearing and longstanding ILS funds are underwriting weather derivatives for agriculture clients. This is where Bermuda leads the world in underwriting impactful insurances to further the ESG mandate.

For years the insurance market was trying to find a way around the fundamental requirement for an insurable interest and in Bermuda our Insurance Act 1978 specifically allows for insurance risk to be written with parametric triggers or on a derivative basis.

This ability to provide parametric financial products for weather, climate and other natural catastrophe events moves the needle significantly and allows underwriters to speculate on natural catastrophe risk without needing to provide indemnities as they would in a traditional promise to pay insurance product.

Parametric coverages can be deployed powerfully in microinsurance for low-income people in emerging markets, or for financial smoothing products for SMEs to address droughts, excessive but not catastrophic rainfall, and loss warranties in geographies with low insurance penetration, further improving the lives of farmers and small businesses that might need financial certainty of production and sales rather than catastrophe cover after a disaster.

Of key importance – and what is not being discussed enough – is the insurance industry must address transition risk inherent in altering corporate strategies and investments as society and industry pursue their goal to reduce reliance on CO2-producing energy sources and their impact on the globe’s climate. Policy and legal risk, reputational risk, technology risk and market risk all need to be addressed and ring-fenced for coverage to facilitate change.

Bermuda’s innovative coverage triggers and efficient access to capital markets risk capital put the island at the vanguard of these coverages – actual and potential – and will assist with ESG strategy, investment capital allocation and ESG metrics and reporting. 

What other initiatives is Bermuda pursuing as it looks to remain at the forefront of the (re)insurance industry’s evolution?

Bermuda has embraced fintech and insurtech opportunities by passing digital assets and insurtech legislation, and the Bermuda Monetary Authority offering a range of full and testing/sandbox licences.

Bermuda’s internationally respected regulatory system, Solvency II equivalence and NAIC reciprocal jurisdiction status allows new entrants to set up in Bermuda within weeks and sell insurance to clients globally.

There is a natural symbiosis between the innovators in Silicon Valley and the risk transfer innovators here in Bermuda.

We have formed many fintech operations in Bermuda for internationally renowned clients and we see many new enquiries for opportunities in insurtech and fintech, often with an ILS element.

Those insurtechs either use technology to better analyse, price or distribute insurance products or are looking to use distributed ledger technology in Bermuda for transacting business, or tokens for risk finance or risk pools.

We are some way away from premia or claims being paid in digital currencies, but it is an inevitability and Bermuda is well placed to provide an innovative, facilitative but responsible regulatory platform for growth in this key product area.

Peter Dunlop is a partner and co-lead of the insurance and reinsurance team of Walkers Bermuda.