Securis’ Cahal Doris looks at coverage, liquidity and partnership in the sidecar arena.

Cahal Doris – Securis

Securis has invested in quota shares and sidecars for well over a decade as an efficient way to access diversifying property risks, and to complement more actively managed segments within our strategy including retrocession, reinsurance (collateralized and fronted), cat bonds, ILWs, specialty and life.

In recent years proportional capacity has become a significant component of reinsurance capital. The 2020 sidecar market is estimated to be sized at $7bn (limit) while the private quota share market is larger at around $12bn (Source: Aon Capital Partners, 2020). Capacity has recently reduced (the sidecar market was $9bn in 2019) so it is interesting to explore the motivations for each party to inform how capital may be attracted back.

Coverage

There is a preference for well-defined portfolios with underlying exposures that are quantifiable and suitable for models/analytics. Following a soft market, there is naturally a certain amount of pruning required:

  • Remove unprofitable lines of business
  • Remove long-tail lines with volatile reserving risk
  • Cap risks that are inadequately priced or not sufficiently quantifiable e.g. wildfire

We expect a minor impact from Covid claims in 2020 where original policies offered “affirmative” nonphysical damage cover and foresee communicable disease exclusions on all new and renewal business at the 1 Jan 2021.

Key motivations

Liquidity

As ever, reserving risk for the (re)insurer has to be balanced with the investor’s need for returns after any trapping-induced cash drag.

The majority of proportional contracts include a mechanism to trap a proportion of collateral by applying buffer factors to loss reserves. Sidecars have separate contracts each year and as a result reserve risk is segregated by accident years. This feature is uncommon in private quota shares as most have pooled reserves for back years.

Following 2017, 2018 and 2019 there is significant downward pressure on buffer factors, and a drive for more efficient ‘rollover’ mechanics such as reserve pooling.

Partnership

We have a strong preference for (re)insurers who show a deep understanding of the product and who see ILS capital as an opportunity rather than a threat. We look for strong alignment with the cedant’s interests and offer constructive guidance using our breadth of knowledge gained working with over a dozen reinsurers in this space.

Alignment of interest

Flight to quality

The 2017-2019 period offered an opportunity to study results rather than models, and this has precipitated a flight to quality. We believe (re)insurers who adapt in response to some of the issues raised will benefit by attracting more capital as the market hardens. Securis has reduced the number of our live QS/sidecars, and whilst prior performance has been a key component of this decision, it is not purely an exercise in picking the lowest combined ratio (after fees of course) – qualitative aspects play a critical role too.

Sidecars are often mischaracterized as a reinsurer acting as fiduciary, yet this is not a simple ‘fund’structure that investors are familiar with. The vast majority of our investors lack the institutional knowledge to invest directly in sidecars, but see the value proposition in taking on diversifying reinsurance risk whilst avoiding the conflicts of interest associated with the reinsurer-aligned ILS model. Ultimately, for all but the largest pension funds with dedicated ILS teams, the complexities around risk management, valuation and liquidity are often best handled with a specialist manager. Quota share and sidecar investors will continue to drive underwriting quality by rewarding good companies offering well structured products. We look forward to observing how this segment continues to evolve at 1 Jan 2021.