UK ILS reforms more likely to take activity from other jurisdictions than generate net-new: Fitch

The recently announced consultation on reforming the United Kingdom’s insurance-linked securities (ILS) risk transfer regulations is more likely to result in activity being taken by the UK that would have been booked in other jurisdictions, than to generate net-new ILS business, commentary from Fitch Ratings states.

Fitch has commented on the UK government proposals to reform its regulatory regime for insurance-linked securities (ILS) arrangements and for the insurance special purpose vehicle (ISPV) structure that can be used for transactions.

Fitch cautions that while these proposed reforms, which we reported on when they were recently announced with a new consultation, are designed to ease the regulations while expanding risk transfer options to be more in line with global competitors.

The ILS reforms were announced alongside a new captive regulatory regime and Fitch comments on both together, saying they show the government looking to “revive” its ILS ambitions.

“The UK government’s proposed reforms of insurance risk transformation and captive insurance are credit-neutral for London market insurers as existing regulatory standards will continue until implementation in 2027,” the rating agency said. “However, the reforms may raise systemic risks in the longer term if risks move out to less transparent market segments.”

Fitch notes the proposals include “proportionately lower capital requirements for ILS vehicles and captive insurers, reduced application and administration fees, a faster authorisation process and lighter reporting obligations than for fully authorised insurers and reinsurers.”

On systemic risk fears it raises, Fitch states, “Once the reforms are implemented, there is potential for growing pockets of risk to accumulate outside the core regulated insurance sector. Risks would shift to the institutional investors that provide the funding for ILS vehicles or stay with corporates that set up captives, with lighter regulation and capital requirements. This could lead to gradual disintermediation of the non-life insurance industry and make it more difficult for regulators and market participants to monitor the true distribution and concentration of risk.”

Of course, the development of the ILS market has not resulted in systemic risk so far, although it has disintermediated the market to a degree. But, it has done so as a complementary source of reinsurance risk capital (albeit differentiated, backed more directly and accessed differently) and it would seem necessary for significant expansion of the ILS market to occur for such systemic risks to emerge.

But it does not seem Fitch is envisioning any major expansion of the ILS market, or captives, with the reforms the UK has proposed.

“Most of the new ILS and captive business that the UK could gain is likely to come from activity previously booked in other jurisdictions rather than from a significant shift in risk-taking behaviour among insurers. Additionally, insurers are likely to remain involved as arrangers or facilitators for ILS and captive structures, retaining a degree of oversight and control over underwriting and risk management,” the rating agency said.

Finally, Fitch comments on the risks of contagion across protected cell structures, something the ILS market has solved through strict segregation of risks and assets, as well as regulatory regimes having dealt with this issue for years.

Fitch stated in its commentary, “The reforms also expand the scope of ILS by allowing transformer vehicles to take risk from multiple counterparties, including non-insurers. Similarly, protected cell companies will be able to assume risk from more than one party, enabling multiple companies, particularly SMEs, to access risk-transfer arrangements without setting up standalone vehicles. This could improve accessibility and flexibility, but it may also increase the risk of contagion across cells.”

Of course, as a rating agency, Fitch does need to provide cautionary warnings of any risks related to regulatory change and how it could affect the established insurance and reinsurance market.

It seems the concerns of systemic risk, caused by a disintermediation or risk leaving the traditional re/insurance ecosystem are perhaps issues that the ILS market has managed during its evolution, although worth highlighting and should the market expand dramatically then it could become more of a concern.

While, the risk of contagion across cells should be managed through the legislation itself, in providing for strict protection and segregated cell structures.

But, the point we’ve highlighted in our headline is worth taking notice of. That a reformed and more flexible UK ILS regulatory regime may attract business that would otherwise simply have been transacted in another domicile, but may not generate more ILS business to be transacted overall.

We’d hope that some of the reforms proposed, such as the ability for non-insurance entities to utilise iSPV’s for ILS risk transfer, could drive some net-new ILS market activity.

But, Fitch is probable correct. That the majority of any business the UK attracts for ILS arrangements located there, even after the reforms to the regulatory environment, is more likely to be activity that would otherwise just have been transacted elsewhere.

It seems a natural assumption to make, even if the UK can become more competitive thanks to the regime enhancements and faster authorisation timelines.

Also read: UK Gov confirms new cat bond, ISPV timelines. Launches new consultation to enhance ILS regime.