Just as Hurricane Andrew made waves in the insurance industry in 1992, the UK government could now stir up further significant change in the traditional catastrophe reinsurance market.
Hurricane Andrew was the first event where catastrophe bonds were used to reinsure traditional catastrophe risk and this particular form of Insurance Linked Security is now becoming increasingly prevalent.
A ‘cat bond’ works as follows: An investor purchases a ‘cat bond’ by paying a coupon. If a catastrophe occurs, the reinsurer retains the coupon amount to finance the indemnity payments to policyholders; if the catastrophe fails to materialise by the maturity date, the investor obtains a healthy return, funded by the original premiums.
Although such alternative ‘cat bond’ capacity currently represents only 15% of total property reinsurance capacity, it has been growing steadily in the last two decades and industry analysts predict further high growth potential, driven in part by the superabundance of capital.
Recognising this trend, the recent Coalition Government indicated a desire to encourage the growth of ILS products in the UK reinsurance market and in the 2015 Budget the Chancellor said the Coalition Government would:
“work with the industry and regulators to develop a new competitive corporate and tax structure for allowing Insurance Linked Securities to be domiciled in the UK. This alternative form of reinsurance makes greater use of capital markets and is a key growth opportunity for the sector.”
At present, alternative capital providers typically domicile in low-tax locations to take advantage of lower costs. To put this in context, more than 85% of ILS issuance between 2009 and late 2013 was by companies located in the Cayman Islands and Bermuda.
Some commentators suggest that, even with regulatory change, the UK could never be as tax-competitive as these jurisdictions and industry experts have queried how any new regulatory framework would avoid conflict with Solvency II requirements.
However, other commentators consider that the UK is perfectly placed for ILS due to the strength of its legal system and the Chancellor’s announcement has been welcomed by many heads of finance in off-shore jurisdictions, citing London’s willingness to engage and do business as positives for the global (re)insurance market.
Given that the Conservatives remain in power following the recent General Election and George Osborne will remain as Chancellor, we can expect the new Government to be supportive of the changes to the ILS market outlined in the 2015 Budget, but it is too soon to know whether this will be a legislative priority for the new Government.