Maui wildfire, hurricanes Hilary & Idalia may drive attritional quota share losses

We’re told that some managers of insurance-linked securities (ILS) fund strategies that invest into collateralized reinsurance quota share arrangements and private sidecar structures, are anticipating a chance of attritional losses from some recent catastrophe events that have occurred around the globe.

Attritional losses can often leak to ILS investors via strategies that invest in quota shares, as these reinsurance structures can protect ceding companies from nearer to the ground-up.

This is converse to the status with excess of loss reinsurance structures at this time, which encapsulate the majority of the ILS market and all catastrophe bonds and have moved higher up.

Excess of loss reinsurance structures have much higher attachment points nowadays, as one of the key terms improvements that have occurred through the hardening of the market.

At the same time, aggregate excess of loss reinsurance is a much rarer feature of ILS portfolios and where it does persist, these aggregate XoL contracts typically have much higher per-event deductibles in place.

But quota shares remain a proportional, or pro-rata agreement between cedent and the provider of reinsurance capital, sharing in a percentage of underwriting profits and also losses.

So, in these cases, while there are still qualifying terms for events and those terms have certainly hardened in the favour of investors and underwriters, there is still a higher chance of attritional losses leaking to ILS strategies.

Important to note that, it’s not the fact any losses are possible that is a surprise, these are quota shares after all, but the fact they are being discussed perhaps shows that attritional loss experience is becoming less typical via these structures, thanks to improved terms and conditions.

Certain collateralized quota share reinsurance arrangements and reinsurance sidecars had already been passing on losses to their backers for the US severe convective storm activity and hail losses we’d seen through the first-half of the year.

But, in recent months a number of other international catastrophe loss events are also going to result in losses being passes to some ILS funds via quota share arrangements and private sidecar structures, we’re now told.

Among these are the Maui wildfires in Hawaii, which is the largest in industry loss terms of these attritional catastrophes to affect ILS quota share arrangements, we understand. Here, ILS funds are definitely anticipating some losses to flow, as there are said to be two quota share arrangements in particular that have private ILS participation.

Currently those wildfires are thought likely to result in insurance and reinsurance market losses of around $3.5 billion to $5 billion.

Another event where some ILS strategies are anticipating a chance of attritional losses, is from hurricane Hilary and its impacts in California.

While not a hurricane when it reached the state, Hilary was an unusual tropical event for California and industry estimates suggest insured losses could reach to as much as the $1 billion level, we understand.

In addition, hurricane Idalia’s impacts in Florida and other southeastern US states is thought likely to trigger some attritional losses to at least one quota share arrangement, we are told.

There are other events in recent weeks that could also drive some quota share exposure, we understand, with some minor ILS market exposure to wildfires in Canada and potentially to events in Hong Kong and China related to the typhoon season, sources said.

It’s important to note that, in all these case, the losses anticipated from these attritional events are expected to be minor and all the ILS funds with exposure have already factored the potential for some losses to flow through quota shares they invest in into their fund or strategy net asset values.

These events will not derail the very strong performance that ILS funds investing in collateralized reinsurance quota shares and private sidecars are now experiencing, as the seasonal returns flow through the peak wind season months.

Given the much higher returns flowing from these quota share structures, it’s possible the impact of these attritional events is hardly noticed by investors in ILS strategies that have attritional exposure.

Which is another example of the way much improved reinsurance pricing and terms is benefiting the ILS market, as if you went back just a few years some of these attritional event impacts would have been significantly more noticeable and more severely dented returns.

The higher returns are now compensating those investing in quota shares for taking on some of the volatility within insurer and reinsurer results, which should make quota share and sidecar investments ultimately more attractive, once the 2023 returns are delivered and investors have a full year of evidence of how much more insulated from smaller catastrophe event losses those ILS strategies now are.