PSP Investments Dips Into Insurance-Linked Securities

Artemis reports that Integral ILS gets cornerstone commitment from Canadian pension PSP Investments:

Integral ILS Ltd., the start-up insurance-linked securities fund manager launched by industry execs Richard Lowther and Lixin Zeng, has secured its first investor commitment, from Canadian pension giant the Public Sector Pension Investment Board (PSP Investments).

PSP Investments manages around CAD $169.8 billion of net assets and we understand this to be the pension giants first allocation to insurance-linked securities (ILS).

PSP has been exploring ways to enter the ILS market for some years now, we understand.

PSP is already affiliated and has a strong relationship with as a 30% owner of, direct risk originator and distributor AmWINS, which itself has a stake in Integral ILS Ltd.

Integral ILS was launched earlier this year and has been working on securing investor relationships, with a target of starting to build out its first ILS fund portfolio in time for the January reinsurance renewals.

Integral said that PSP Investments has provided it with significant LP (limited partnership) investment commitments to launch a new dedicated ILS strategy.

This new ILS fund strategy will be focused predominantly on natural catastrophe-linked reinsurance and insurance transactions.

“Integral is honored to have been awarded a cornerstone ILS investment mandate by top-tier pension manager PSP Investments. We appreciate the trust placed by PSP Investments in the Integral team and are committed to meeting their high expectations,” Lixin Zeng and Richard Lowther, co-founders and Managing Partners of Integral said.

“The Integral mandate represents PSP Investments’ first ILS allocation as part of our Alternative Risk Premium strategy,” added Eduard van Gelderen, Senior Vice President and Chief Investment Officer, PSP Investments. “ILS is an attractive asset class given its low correlation and diversification benefits for our portfolio. We are excited to enter into a long-term partnership with such an experienced and well- regarded team in the space.”

We understand Integral is aiming to begin by sourcing risk via its relationships with AmWINS and its other stakeholder reinsurance firm TransRe.

These relationships provide the manager with access to risk that can be fully-fronted and also much more diversified, than a typical start-up ILS fund manager would be able to achieve.

That will tick a lot of boxes for a relatively conservative investor like PSP.

Integral will also be able to write direct collateralized reinsurance and retrocession itself as well, using its recently established Bermuda special purpose insurer (SPI) Integral Reinsurance Ltd. (Integral Re).

Integral says that it aims to, “Drive further evolution in the ILS fund management model with an investor- focused fiduciary that also benefits from a long-term and stable alignment with industry leaders in reinsurance and insurance underwriting and distribution.”

We understand further investor discussions are underway and Integral is hopeful of announcing more commitments before year-end.

It's Remembrance Day and typically on this day, I sit down and look at recent deals PSP Investments has made because it is the Canadian pension fund that manages the pensions of the Canadian Armed Forces.

Anyway, this deal with Integral ILS caught my attention. 

Back in July, TransRe and AmWinslaunched launched the new insurance-linked securities (ILS) manager:

TransRe and AmWins have been confirmed as backers for the launch of Integral ILS Ltd., a new Bermuda based insurance-linked securities (ILS) fund manager.

Representatives from Integral informed our ILS-focused sister publication, Artemis, that the company has launched but remains in the early stages of development.

The fund manager is preparing to deploy capital by January 2021 with support from TransRe and AmWins, who will both take stakes in the company.

TransRe already owns a stake in ILS manager Pillar Capital, as well as its own TransRe Capital Partners division, while AmWINS has experience using its direct risk origination to channel business to ILS capital.

The backing of these two re/insurers is expected to assist Integral ILS in gaining access to re/insurance business, as well as fronted access to the open market, which TransRe also has some experience in.

The senior leadership at Integral ILS will be Richard Lowther, ex-Managing Principal of Hiscox ILS and Lixin Zeng, ex-CEO of AIG’s AlphaCat ILS unit.

They will be joined by Matthew Swann, Adriaan Van der Merwe and Emily Birrell, all of who are former Hiscox ILS employees.

Integral ILS remains focused on capital raising for now, but hopes to begin deploying capital and building a portfolio ahead of the January 2021 renewals.

Catastrophe risks will be the main focus and it will write insurance, reinsurance and retrocession, sources confirmed, with a special purpose insurer (SPI) likely to be utilized to begin with.

From the first press release above, it is clear Integral ILS got a significant capital commitment from PSP Investments and if I were PSP and Integral, I'd approach HOOPP to also commit capital to this new fund.

Why HOOPP? Because back in September, I spoke with HOOPP's CEO Jeff Wendling about their LDI 2.0 in a zero bound world and he specifically mentioned they are looking to allocate to insurance-linked securities:

In addition to infrastructure, it launched an insurance-linked securities (ILS) program. I'm not an expert on this but read a great comment on it from Marsh here. Basically, "ILS is another form of reinsurance available to insurance entities. However, instead of facing a rated balance sheet, the insurance entity faces a fully secure, collateralized form of funding dedicated to a precise risk requiring coverage. Usually the collateral takes the form of highly-rated, highly-liquid investments, such as government gilt funds or pure money market funds. Premium flows are determined by the type of risk and investor appetite."

If you've just heard about insurance-linked securities, take the time to read this comment from Marsh:

Increased pressure for growth and the need to be nimble in reaching financial objectives has made Insurance Linked Securities (ILS) an attractive capital efficiency option for many organizations in 2017. But what exactly is ILS and how does it tie in with captives?

ILS is another form of reinsurance available to insurance entities. However, instead of facing a rated balance sheet, the insurance entity faces a fully secure, collateralized form of funding dedicated to a precise risk requiring coverage. Usually the collateral takes the form of highly-rated, highly-liquid investments, such as government gilt funds or pure money market funds. Premium flows are determined by the type of risk and investor appetite.

How does ILS work?

The collateral for ILS is provided by capital market investors, for example an ILS investment fund, pension funds, institutional investors, and even other insurance companies. Such investors will purchase debt or equity issued by the ILS vehicle and will receive a coupon for this investment. Their capital is committed for the duration of the risk period and invested in the collateral account held on behalf of the ILS vehicle by a third-party trustee.

Traditionally, ILS has been used as cover for property catastrophe (CAT) type events, typically for windstorm or earthquake. Therefore there has been significant reliance on established modelling to demonstrate the nature of the risk to investors and provide more certainty about the event trigger as it relates to a specific event.

However, new risks are emerging for which this type of reinsurance is being used:

  • A Swiss-based investment bank brought an operational risk insurance transaction to the market in 2016, via a quota share arrangement with a leading primary insurer.

  • A European motor insurer transferred some of its motor third-party liability book to the ILS market towards the end of 2016.

From an investment point of view, ILS is considered  ”just another asset class,” but has always been seen as  uncorrelated to stock market movements, as ILS are generally only affected by the ‘wind blowing’ or the ‘ground shaking.’ The estimated size of the ILS market at the end of the third quarter of 2017 was approximately US$75 billion. Approximately US$30 billion of this market consisted of 144A CAT bonds (a syndicated debt issuance subject to SEC restrictions) with the remainder collateralized reinsurance transactions (usually one to two investors taking on the risk).

What about captives?

For companies with a captive entity as part of their risk management program, the captive can provide a means to reinsure corporate risks through ILS. This proves especially useful when there is limited capacity in the market for the type and level of risk involved or there is a desire to diversify the reinsurance tower.

Coverage can be provided through a Cat bond issuance or in smaller risk amounts using collateralized reinsurance programs. Coverage is negotiated directly between two counterparties with the risk transferred though an ILS transformer platform, which acts as the common link between the captive and the investor.

Some examples we have seen of captives using ILS for reinsurance include:

  • Captive 1: In this transaction, the captive placed a US$200 million layer of coverage with a Bermuda ILS vehicle that provides coverage for storm surge risks and is based on a parametric trigger. Trigger events are linked to actual surge heights during named storms as measured by tidal gauges in key locations around greater New York City and the island of Manhattan.

  • Captive 2: This captive placed US$275 million in reinsurance through a Bermuda ILS vehicle for named storm-related surge and wind risks, as well as earthquakes. Utilizing a parametric trigger, the CAT bond can be triggered if key intensity measurements of the physical parameters for each respective peril, captured at specified measurement locations, breach certain levels.

  • Captive 3: Through a Bermuda ILS vehicle, this captive placed US$300 million of US earthquake risks, focused on the west coast and featuring a parametric trigger.

Putting captives’ capital to work

For captives, placing a higher layer of their reinsurance tower through an ILS structure provides access to collateral funds for low frequency, high impact events that can be released in a relatively short time frame. This means that funds can be put to work to help rebuild the captive parent’s business or to deal with client’s needs. There may also be positive solvency capital implications (especially in a Solvency II world) as the captive can ‘look through’ to the rating of the collateral being posted by the ILS vehicle.

Marsh & McLennan Companies, through GC Securities[1], a division of MMC Securities LLC, and Marsh Captive Solutions have now launched Cerulean RE SAC Ltd (Cerulean), which is a Bermuda-authorized Special Purpose Insurer that provides access to collateralized reinsurance by utilizing ILS in an efficient and cost-effective manner. Through standardized transaction documentation, Cerulean provides a single point of access for cedents/captives to long-term capital markets-based protection and to capital markets investors seeking suitable investments in (re) insurance risk.

The future options for the use of ILS as a complementary form of reinsurance are unlimited, especially as interested capital market investors become more sophisticated in their underwriting capabilities and gain a deeper understanding of the risks they are willing to take on.  

I posted this comment to show you a few things:

  • The ILS market is growing and catastrophe bonds (Cat bonds) make up the bulk of the market but other forms of reinsurance risks are being collateralized. 
  • Insurance-linked securities are considered an asset class that has little to no correlation with stocks and bonds and are thus attractive to large pensions looking to diversify their returns.
  • The market is growing, it is scalable and that too is of interest to large pensions looking for scale.
  • There are risks in the ILS market which is why it makes sense to partner up with experts.

Artemis recently posted an article on how the Cat bond market is benefiting from a “flight to simplicity” in ILS:

The flight to quality in the insurance-linked securities (ILS) market has been well-documented, as some investors have opted to shift allegiance to ILS fund managers that are deemed higher quality, due to their longevity, track-records, or affiliations.

But now we can add to that a “flight to simplicity”, coined by RenaissanceRe CEO Kevin O’Donnell recently, specifically referring to the catastrophe bond market.

Together, quality and simplicity cover a lot of the bases that institutional investors are seeking within the ILS asset class at this time.

Institutional quality, quality of the portfolio of risks invested in, quality of track-record, quality of process, strategy, documentation, reporting, terms and conditions, people and partnerships, amongst other factors.

Simplicity goes hand-in-hand with some of these, particularly around the terms, conditions, precision of coverage and understanding of the potential for losses.

Nobody would ever say that catastrophe bond documentation is simple.

But the extensive nature of it, with well-defined terms and named perils often the focus, does make the predictability of what may happen during the term of a cat bond, in terms of losses or otherwise, or extensions and trapping of collateral, much simpler to understand and anticipate.

Compared to collateralized reinsurance portfolios, where terms can differ much more significantly from deal to deal, while coverage can be much broader, and trapping of collateral a little less predictable as a result.

Simplicity might also be termed certainty, as that it what investors are looking for at this time.

Not certainty that they won’t face a loss.

Institutional investors such as pension funds are extremely realistic when it comes to the ILS asset class and their potential to face losses.

Having performed their due-diligence and understood what it means to invest directly into assets that are exposed to insurance and reinsurance risk events, investors in ILS expect they can lose a lot of their allocation in a particularly bad year, some of it in a number of years and occasionally have relatively loss free years.

But greater certainty that the loss will be via an event that was expected, more predictable, less surprising and certainly not completely unexpected or unanticipated, is welcomed by many of them.

The catastrophe bond market offers a lot of these certainties and a good deal of simplicity, compared to more complex portfolios of reinsurance and retrocession underwritten in numerous forms of coverage, with numerous types of documentation.

Which is, of course, the natural way of the ILS market, that both these products are available and often are co-mingled together in ILS funds, that allocate a portion of their assets to the less simple, sometimes less certain collateralized reinsurance, with a portion also allocated to the perhaps more simple and certain catastrophe bonds.

On the heels of three years of major catastrophe losses and facing a fourth year of trapped collateral due to the COVID-19 pandemic, there is little surprise we’re seeing these flights, to both quality and simplicity.

RenaissanceRe’s CEO Kevin O’Donnell highlighted this for the catastrophe bond market, saying that his firms cat bond focused Medici fund had one of its best performances in its history in the third-quarter and looking forward, “we expect it to continue to benefit from the flight to simplicity the cat bond market is currently experiencing.”

Over the years, through the rise of collateralized reinsurance, repeatedly major pension funds and sovereign wealth investors have expressed a desire for more cat bond issuance, as the fully-securitized nature of an asset with features of secondary transferability, aligns much more closely with the kinds of assets they are used to investing in.

Cat bonds, in many institutions eyes, sit alongside other forms of debt and credit securities, in terms of how investable they are.

Where as collateralized reinsurance is often seen as more of a hedge fund type strategy, where a manager constructs investable portfolios from assets that aren’t immediately designed to be consumed in such a way.

Of course, at their heart, the two are much the same.

An insurance or reinsurance agreement, collateralized fully in some way and transformed into a security that can be invested in or consumed into an investment fund.

But the note like output of a full Rule 144a catastrophe bond issuance is still seen as the simpler investment option, which is why some larger pensions and multi-strategy investors allocate to the cat bond market directly, but don’t do the same with collateralized reinsurance.

Cat bonds also hold an element of simplicity for investors as they are a fully-underwritten asset, where analysis and modelling is done upfront by third-party service providers and the deals underwritten by experts, before the notes are issued, marketed and sold.

Cat bonds are also more broadly marketed, by broker-dealer groups, making them more accessible to more types of investors.

Collateralized reinsurance, on the other hand, requires access to risk and underwriting expertise in order to gain the contracts to be transformed, securitized, and invested in.

Cat bonds seem more readily investable and more easily so, to the majority of investors.

None of which is to say catastrophe bonds aren’t complex, hard to understand, don’t require underwriting knowledge of the risks and an ability to model them. They are also full of nuances, sometimes opaque and lacking in details of the underlying exposures.

But, at a time when the insurance-linked securities (ILS) market has faced losses and trapped collateral to the degree seen in the last few years, the catastrophe bond is coming out as a simpler, cleaner, perhaps more broadly accepted option, in some investor circles.

Alongside the flight to quality, this flight to simplicity will benefit the catastrophe bond market greatly and we could see a significant step up in size of the outstanding cat bond market (as a proportion of overall ILS assets) over the coming decade, we believe.

Already, 2020 has beaten its first annual record for the catastrophe bond market and right now seems set to beat pretty much all of the others.

Add to this the evident expansion in the range of cat bond sponsors that we’re seeing, such as the news of Google parent Alphabet seeking to become a cat bond beneficiary yesterday, as well as the entry of other new sponsors this year, and the future looks bright for catastrophe bonds.

You can keep up-to-date with the make-up of the catastrophe bond and ILS market using the Artemis Catastrophe Bond & ILS Market Dashboard, designed to be a simple and effective tool providing key data and statistics on every transaction (there are 700+) contained in their catastrophe bond & ILS Deal Directory.

Now, I did promise to cover other deals PSP Investments made but I'm going to keep that coverage short:

  • Cubico Sustainable Investments has finalized the acquisition of a 16-MW portfolio of Italian wind farms for an undisclosed sum.The renewables investor, which is backed by Ontario Teachers’ Pension Plan and PSP Investments, said on Monday it has taken possession of two operational wind parks located in the Campania and Apulia regions. The assets, dubbed Bisaccia and Torretta, were acquired from Italian firm Blunova Srl.
  • Tishman Speyer, one of the world's leading owners, developers, operators and fund managers of first-class real estate around the world and PSP Investments recently announced the sale of Tour Pacific to Société Générale Insurance for an undisclosed amount. PSP Investments and Tishman Speyer acquired the 53,000 sq.m. office building, located in Paris' La Défense business district, in 2013. Following an extensive renovation and refurbishment program that transformed this 20-year-old office tower into a modern and efficient building, they have successfully leased approximately 50,000 sq.m. to over 30 tenants including CA Technologies, McAfee, Whirlpool, Manhattan Associates, RSA, NTT and Accenture.
  • In a separate deal, Tishman Speyer and PSP Investments acquired the Espace Lumière building in Boulogne Billancourt, a suburb of Paris, from a fund managed by Invesco Real Estate for an undisclosed amount. I expect them to refurbish it and sell it down the road (five years from now).
  • In September, AirTrunk, a hyperscale data centre specialist, announced it would be entering into the biggest data centre market in Asia (excluding China) with a plan to construct a new 300+ megawatt (MW) hyperscale data centre campus in Inzai, Tokyo. The initial ~60 MW phase of the campus is targeted to open in late 2021 to support anchor customer demand. Earlier this year, a consortium led by Macquarie Asia Infrastructure Fund 2 (MAIF2), a Macquarie Infrastructure and Real Assets-managed infrastructure fund, and including PSP Investment, acquired an 88 per cent stake in AirTrunk, valuing the company at more than $A3 billion and providing necessary capital and expertise to further realize AirTrunk’s expansion plans across APAC. 

These are just some of the recent deals PSP Investments has entered with its partners and I'm sure there are plenty of others but PSP isn't big on providing details on all its deals, only the major ones make its news hub

What else? This week, I noticed PSP's Revera disaster is only getting worse as news broke out of a spike in deaths and COVID-19 cases at Edmonton and Winnipeg long-term care facilities owned by Revera (see details here).

It's fair to say 2020 has been a disastrous year for public and private long-term care facilities struggling to cope with the pandemic. I'm not sure how PSP and Revera are going to handle the blowback but there's no doubt in my mind that they need to reassess the pros and cons of owning long-term care facilities.

Lastly, today is Remembrance Day and I called my 88-year-old father to get the story of what happened to his father at the end of World War I.

My grandfather after whom I was named left Crete at the age of 17, got on a boat and ended up at Cedar Rapids, Iowa where he worked at a factory making starch for shirts (big thing back then).

He fought for the US Army in World War I and on November 11th, they were on a train in France close to the German border when all of a sudden French people surrounded the train screaming: "Bosch Caputo!" (the Germans have fallen).

The US Army sent my grandfather and other US soldiers to Nice to relax where my grandfather stayed at the Atlantic Hotel. From there, they were taken to Marseille where my grandfather walked in the bazaar and heard some people working there cursing in Greek (there were quite a few Greeks living in Marseille at the time).

When World War I ended, my grandfather went back to the United States and settled right outside Chicago near the Indiana border. He worked as a mechanic for a large company manufacturing sewing machines and told my father that every Friday, people would cross the border from Indiana to Illinois to drink (prohibition was still in effect in Indiana, not Illinois).

He worked for a few years in the US after WWI and then moved back to Crete where he met my grandmother and had two kids, my father and my aunt. 

My grandfather didn't talk much about the war but he always spoke fondly of the United States and so did my grandmother as she received a pension from the US Army and after his death, she received it and was always grateful.

That's another generation, a great generation, and we should all remember the sacrifices they went through.

My father told me another story, during World War II, he was a young boy and he remembers they left Iraklio, Crete to go my grandfather's village outside the city (Kani Kastelli now called Profitis Ilias). 

They didn't have much food, were always hungry and cold and there was no electricity so at night they burned a wick in olive oil for light and it smelled.

The Battle of Crete ended up being a pivotal one during the Second World War and there are a lot of great books written on it but my favorite ones remain G.C. Kiriakopoulos's Ten Days to Destiny: The Battle for Crete and Anthony Beevor's Crete 1941: The Battle and the Resistance.

If you're a history buff, read these books, they're phenomenal. You will also understand why millions of Germans are in awe of Crete and have visited the German war cemetery in Maleme outside Chania, one of the most important monuments of World War II in Crete. 

More than 15,000 German soldiers lost their lives during the Second World War in the Greek territory. The German military cemetery in Maleme is one of the two cemeteries in Greece where the graves of German soldiers are (the other cemetery is the German military cemetery Dionysus - Rapentozis in Attica).

Those were crazy times which is why my father and his Cretan friends don't have fond memories of their childhood, quite the opposite. 

That's also why my friend's father who also grew up in Crete during WWII calls us "The Butter Generation" because we never had to live through the real and brutal hardship of war (Thank God!).

It's important we remember all this now that we are living through a pandemic. We will come through this, we always do. Take the time to honor and remember those who lost their lives defending our freedom and those who continue doing so.

Below, PSP Investments invests funds for the pension plans of the federal public service, the Canadian Forces, the Royal Canadian Mounted Police and the Reserve Force. PSP's CEO Neil Cunningham shares what Remembrance Day means for them and why they are proud to count Veterans among their people.

Also, if you watch one thing today, watch this boy's reaction to his father's surprise return from a deployment in Afghanistan. Priceless (also embedded the tweet with video below).

Third, BCI's Manager of External Communications, Ben OHara-Byrne, shared this report he once did on the mother of a Canadian soldier killed in Afghanistan returning to the military base in Kandahar to honour his memory.

Lastly, a documentary that recounts the German airborne invasion by the elite Fallschirmjäger of the Greek island of Crete in May 1941.

The Battle of Crete was the first occasion where Fallschirmjäger (German paratroops) were used en masse, the first mainly airborne invasion in military history, the first time the Allies made significant use of intelligence from decrypted German messages from the Enigma machine, and the first time German troops encountered mass resistance from a civilian population.

Update: Mihail Garchev, the former Head of Total Fund Management at BCI, shared great insights with me after reading this comment:

I think a big part of such strategies' success is much more how and who implements these as opposed to the underlying securitized product. Because we could talk about ILS, but this is not a homogeneous thing, certainly not (yet) an asset class, and not (yet) sufficiently commoditized.

Given the above, what would matter is not to be in “ILS” for the sake of it, be it perceived characteristics related to diversification, etc. but having the right structure. This platform investment has the specialized expertise and experience in managing such exposures. PSP has an excellent record of approaching complex and novel investments capitalizing on the power of platform companies and specialized expertise, and it really makes a difference both from asset management and risk management but also the sourcing of new opportunities, expanding the reach and having a “foot in the ground.” 
Many of the Canadian funds have one way or the other a similar approach. The last is even more critical in today’s environment where both sourcing, due diligence and asset management face the challenges of travel and other restrictions. I remember somebody I respect a lot saying years ago related to the discussions on foreign offices, that PSP already has many “offices” globally because of the strong partnerships. This is why partner network and quality are an essential input in any private portfolio “optimization.”

Another point is that although something might be called the same, it does not mean that the expectations should be the same. For example, and this gets back to expertise, how PSP would approach Private Debt might be very different from those who would like to explore this strategy, saying, “we do Private Debt as well.” It is because there are specific ways how the strategy is thought about from the perspective of competitive advantages, timing and second-order benefits, structured and executed, and where (in NY in this case) which requires the people and expertise like David Scudellari, one of the highly regarded in the financial community, and a gentleman, to make it successful.

All of the above is very important because underneath the complex terminology and deal structure is the basic premise of a product, maybe a future asset class, where one regularly receives a premium but might face rare but substantial liability if the risky event materializes. The latter also describes selling put options, let us say, on an index and collecting the premium until the index gets a major negative hit, and the investor needs to pay. This is why the regular premium would show little volatility and correlation, almost like a bond, until the adverse event happens. Any diversification properties need to be properly accounted for and embedded in a proper risk measure from this perspective. But at least at this point, the best risk management has a well-thought-out structure, and expertise and experience, and it seems PSP has been doing precisely this the right way. Congratulations to Eduard and Neil!

Indeed, congratulations to Eduard van Gelderen and Neil Cunningham, they thought their approach to ILS very carefully and took the right approach by helping to launch Integral ILS. This will be yet another PSP platform specializing in another important investment strategy. I thank Mihail for his sharing wise insights.