The question is whose body count numbers will be accepted by both the underwriters and the ILS investors © Misha Friedman/Getty Images

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Joe (to coffin maker) Get three coffins ready.

(gunfight ensues)

Joe My mistake. Four coffins.

A Fistful of Dollars, 1964

Mortality predictions are an uncertain business. Some (gunmen) will have under-discounted losses. Others (coffin makers), over-discounted revenues. The trick, clearly, is to ensure one is in the second category.

This has been the issue bedevilling the reinsurance industry since the onset of the Covid-19 crisis. With more than $650bn of capital committed to global reinsurers at the middle of last year, reinsurance, especially for natural catastrophes, had been overcapitalised relative to the premium income on offer, and returns had been suffering.

The Caribbean hurricanes and Japanese typhoons in recent years have created bigger losses, stretched out over longer periods, than underwriters and their insurance-linked securities (ILS) co-investors expected. The reinsurers could curse Florida lawyers and cheap money, but their ILS clients in the capital markets have been losing patience. The market for catastrophe (“cat”) bonds has stagnated, despite offering premium returns over corporate bonds.

And that was before Covid-19. Among the biggest traditional reinsurers, Munich Re reported a coronavirus-related loss estimate of €800m in the first quarter. Swiss Re attributed $476m in virus-related underwriting losses. The second quarter impact is likely to be much worse.

The good news, as Swiss Re reports, is that property and casualty premium volume is up 4 per cent, with nominal price increases of 8 per cent. The customers are, finally, being terrified into paying up for coverage.

What if one could get the higher reinsurance premium income for offering pandemic coverage while not being dragged down by historic losses and legal fees? Well, there have been teams of actuaries and underwriters working on that problem for the past couple of months.

Luca Albertini, chief executive of Leadenhall Capital, a London-based ILS manager with $5.5bn of assets, says the group is structuring a pandemic reinsurance product for both its own balance sheet and for outside investors.

“We have been out in the market for about a week. It will be structured not as a bond but as a collateralised cover. The trigger [for paying out claims] will be based on a body count [for each country covered] plus the imposition of an official lockdown.”

While Leadenhall’s pandemic ILS will be priced based on the mortality experience from Covid-19, that virus and its mutations will not be covered by the new ILS. But the Covid-19 mortality data can be used to predict how the next pandemic will play out.

Mr Albertini says: “The model is OK, but we need to verify where the trigger level should be. The capital markets [ILS investors] would not agree to offer it below the Covid body counts.

“If you had a body count around the upper end of actual total mortality over the past three months, then you can [have a margin over the risk-free curve] of about 7 per cent to 10 per cent. With a higher body count as the trigger, you can go to 5 per cent. I don’t think you can go below five.”

Then the question is whose body count numbers will be accepted by both the underwriters and the ILS investors. And should those be global, or country by country? Mr Albertini says: “I would rather not have worldwide [body counts]. We are thinking something more like the UK, France, Japan and so on,” by using numbers from national statistics offices.

Payouts would be quick, based on a transparent methodology. Mr Albertini demurs on whether Leadenhall would underwrite US pandemic mortality. “The US is an important business for most of our clients.”

Mr Albertini started analysing pandemic risk at Swiss Re in 2003, and the Zurich community of reinsurers and ILS managers will probably be central to underwriting new issues.

Dirk Schmelzer, a partner with Plenum, a $426m Zurich ILS manager, is interested in new pandemic plays. That’s understandable. Plenum’s most direct exposure to “excess mortality” is a modest position in Swiss Re Vita Capital 2015-1 A Notes maturing in January 2021.

Marked at 90 cents, they have a yield to maturity of 23.5 per cent. As long as mortality rates in the UK, Canada and Australia rise by less than 15-20 per cent over what was expected, investors win. “The risk adjusted return looks fantastic”, Schmelzer says, “but you would probably have to pay up to get more bonds.”

Of course there will be a first-mover advantage in the pandemic market. So it is a good idea to have that coverage (or extra coffins) ready for the customers.

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