London calling...new legislation aims to establish UK as a major new ILS hub

Will the recent approval of UK Insurance Linked Securities (ILS) regulations see London establish itself as a major jurisdiction for ILS?

Hiscox Re & ILS’s Richard Lowther – Chief Operating Officer for the ILS business – and Paresh Thakrar – COO for Hiscox Re and a member of the London Market Group’s ILS Taskforce – deliver their views.

What do the new UK ILS rules mean?

Paresh Thakrar: “Firstly there is now the possibility of setting up special purpose insurers (SPIs) in the UK which wasn’t possible before the introduction of the appropriate legislation and FCA/PRA guidelines.

“Secondly, the SPI vehicles are tax exempt from corporation tax. If you are an investor, you can invest in these vehicles in London and you will be charged tax as per your home jurisdiction (as happens now in Bermuda).

“Thirdly the rules have put into place an authorisation procedure. The PRA has a rule book that they have to follow in order to approve SPIs and a process for participants to follow.

“Having ILS business in London doesn’t give you the ability to do anything that you can’t already do in existing jurisdictions – it is not giving new tax advantages or a different structure. If anything it might be a little bit more onerous to get things done at first – but that’s fine – we recognise that it will take time for the regulator to get up to speed with the market and how it operates; that’s part of the industry’s responsibility as well to help move things along. At the moment it’s about bringing London into the market rather than pushing new boundaries.”

What can London offer the ILS world?

Richard Lowther: “We’re in the business of marrying risk and capital. There are some investors, particularly in Europe, who currently find it harder to access an ILS product in an offshore jurisdiction. Passporting into Europe as an ILS manager and tapping into investors in the parts of Europe who don’t easily transact offshore has great appeal. There are deep pools of capital in many European jurisdictions that currently have limited ILS investment opportunities - London might help address that shortfall.”

PT: “The ability to transact in London also brings a certain amount of credibility and legitimacy to ILS. The move will open people’s eyes to the fact the asset class exists. London has had a big shift in mindset to allow ILS business to happen here and that can only be positive for ILS as a whole.

“Let’s also not forget that London is a big home for placing insurance risk, including some of the emerging classes such as cyber and flood. There’s a deep talent pool, a large investment community and a credible marketplace in Lloyd’s.”

RL: “Post financial crisis, ILS proved that it truly was uncorrelated with the broader financial markets – delivering attractive returns, and in the case of cat bonds, liquidity in an otherwise dire investment landscape.

“The ability to transact in London also brings a certain amount of credibility and legitimacy to ILS. The move will open people’s eyes to the fact the asset class exists. London has had a big shift in mindset to allow ILS business to happen here and that can only be positive for ILS as a whole.

“Instead of ILS being characterised as ‘hot money’ funded by opportunistic hedge funds popping in and popping out of the market, large institutional investors took notice. Institutional investors now view reinsurance as an asset class, the cheques they write are big and their investment time horizons are long. While this has had a dramatic impact on the market, this is a much better source of long term stable capacity for reinsurance companies. Its move into London is another step on that journey.”

Will there be a rush to re-domicile ILS funds in London?

RL:  “For Hiscox’s existing ILS funds, Bermuda is their home. As a major global reinsurance hub the island works very well and there is no need to change that. But we do source a significant amount of business for our ILS funds through London and having an ILS management presence in London is very appealing even for offshore funds.

“As far as creating onshore structures in London, the SPI framework can support the transformation of risk for ILS funds, sidecars, cat bond structures, etc. In addition to property catastrophe business, Hiscox has underwriting expertise in many re/insurance lines of business generated in London.  We are looking to drive innovation with new products matched with long-term stable ILS capacity.” 

What are the implications for other ILS jurisdictions?

RL: “Some of the offshore jurisdictions were nervous when the UK government first announced its intention to push through ILS legislation but it has meant that ILS has graduated to the status of being a legitimate and investible asset class for mainstream institutional investors.

“As far as creating onshore structures in London, the SPI framework can support the transformation of risk for ILS funds, sidecars, cat bond structures, etc. In addition to property catastrophe business, Hiscox has underwriting expertise in many re/insurance lines of business generated in London.  We are looking to drive innovation with new products matched with long-term stable ILS capacity.” 

“Where we have risk that that is very specific to the London market and we have European investors it absolutely makes sense that you can do all through London, so why wouldn’t you? But I think London will be more complementary to existing jurisdictions rather than taking business away.

“There is plenty of room to grow the overall size of the ILS pie if we think about some of the insurance protection gaps that exist – particularly in the area of flood insurance for example and other specialty lines of business such as cyber. Expanding the universe of risk is going to be helpful – there is enough room for everybody.”

What impact might Brexit have on London’s ILS drive?

PT: “Brexit could be problematic. The passporting issue is key not just for the funds but for insurance and banking more broadly. I’d be surprised with most of the European fund management industry based here if there was anything done through Brexit to jeopardise that. Many other non-EU jurisdictions get equivalence but I think the process would be a bit more cumbersome than it is today.

“If ILS isn’t successful here in London though I think it would probably be for other reasons than it would be for a failure related to Brexit.”

“We shouldn’t underestimate the role of technology in making this happen. If it wasn’t for the quantitative tools that we have – the systems, the modelling capabilities to show to investors what the risk profile of a portfolio looks like – then investors really wouldn’t be interested in ILS as an asset class.

RL: “This ILS legislation provides a capability that will be novel to have in an onshore financial jurisdiction in Europe and it would be a great shame if Brexit meant London could not easily access the European investor base.”

What does success look like for ILS in London?

PT: “We’re likely to see a modest start and speed to market will be an initial challenge. Most importantly, getting the regulator comfortable with ILS by seeing a few successful transactions through and testing that process would be a great year one achievement.”

RL: “We shouldn’t underestimate the role of technology in making this happen. If it wasn’t for the quantitative tools that we have – the systems, the modelling capabilities to show to investors what the risk profile of a portfolio looks like – then investors really wouldn’t be interested in ILS as an asset class. They understand that ILS is not correlated with the wider financial markets but if they can’t understand the potential downside it’s a bridge too far to invest. Again, London can help drive more innovation and use of technology to further develop the ILS market.”