2013: Insurance-Linked Securities - As Alternative Risk Transfer Goes Mainstream, the Reinsurer Business Model Is Changing


Price : $1,750.00



This study on Insurance-Linked Securities (ILS) reviews this growing market for alternative risk transfer from the perspective of both the re/insurance company issuers of these securities as well as investors in the space.  The ILS market, which includes catastrophe bonds, collateralized reinsurance, side-cars and industry loss warranties, provides alternative coverage primarily for property catastrophe risks.  The market began in the mid-1990’s and has developed into an estimated $35 billion in reinsurance capacity, or approximately 15% of the traditional catastrophe reinsurance market.  Investor interest in the ILS asset class has been driven by attractive returns and the low correlations that these investments have with most other asset classes.  The study also reviews the response by reinsurers, whose business model is changing by establishing ILS capabilities in order to provide these alternative solutions to their clients.

1.  Introduction 

2.  Executive Summary 

3.  Overview of Insurance-Linked Securities 

  • Alternative Risk Transfer Vehicles
  • Comparison of Risk Transfer Products
  • Traditional Insurance Risk Transfer—Reinsurance
  • Summary
4.  History and Development of the ILS Market
  • Growth of the Catastrophe Bond Market
  • Expansion of Collateralized Reinsurance
  • Sidecar Issuance
  • The Growing Reinsurer Participation in ILS
  • Summary

5.  ILS Historical Returns and Performance 

  • Components of Return
  • ILS Absolute and Comparative Returns
  • Catastrophe Bond Defaults
  • Summary

6.  Risk Transfer Overview: Process and Participants 

  • The Risk Transfer “Food Chain”
  • ILS Investors—Underwriters or Asset Managers?
  • Loss Triggers
  • Other Parties and Participants
  • Summary

7.  ILS Considerations as an Asset Class 

  • Investment Characteristics of ILS as an Asset Class
  • ILS Impact on Economic Value of Insurers
  • ILS Held by Insurers
  • Summary

8.  Growth Opportunities and Implications 

  • Growth in ILS: New Issuers or New Perils?
  • The ILS Market and Cyclicality—The End of the Cycle?
  • Summary

Introduction

This study on the ILS (insurance-linked securities) market marks Conning’s first such report on the topic. The ILS market has grown substantially since its origination in the mid-1990s. ILS have since become an accepted and integral component of many issuer’s risk transfer financing. Likewise, for investors in these securities, the asset class has grown in popularity due to its lack of correlation with most other types of investments, while offering attractive historical returns.

What is an insurance-linked security? In general, an ILS is an investment whose underlying performance and risk of loss is tied to an insurance risk, often a catastrophic one. An ILS can originate in the form of a bond, a reinsurance contract, an equity investment in a special purpose vehicle, or a derivative instrument, such as an option. The ILS market is made up of catastrophe bonds, collateralized reinsurance, sidecar vehicles, and ILWs (industry loss warranties).

Chapter 3 provides an overview of the ILS market. We describe each of the alternative capital sources as well as provide an illustration of their role in the transfer of risk. We also compare ILS to the traditional reinsurance market, because insurance-linked securities represent alternatives to reinsurance. Whether friend or foe, alternative capital in the ILS market accounts for around 15% of total estimated reinsurance capacity and appears will be a growing percentage.

Chapter 4 provides a history on the development of the ILS market. Much of the history is centered around the catastrophe bond market, for which the most comprehensive data exist. More recently we have seen an increasing convergence among reinsurers into the ILS space. Many reinsurers are establishing strategic relationships with ILS funds and developing their own internal capabilities, in what we view as a shift in the reinsurer business model.

Chapter 5 reviews the historical performance of ILS as an investment class. We compare the performance of a cat bond index to other asset classes, including fixed income and equities. We also cover the historical default experience of cat bonds, including the catastrophic loss events associated with the defaults. Only four bonds have incurred losses as a result of losses triggered by covered perils.

Chapter 6 discusses the risk transfer process including an illustration of the various participants, types of issuers, perils covered, and types of investors and investments that compose the ILS market. We discuss other ILS characteristics including how products are distributed, differences in loss triggers, as well as other participants in the process and the services they provide. We also review some of the leading dedicated ILS investors.

In Chapter 7 we shift gears and review the ILS market from the view of the investor. We review ILS as an investment class and analyze some of the unique characteristics of these securities including correlation, risk and return profile, and an efficient frontier analysis—all in comparison to other asset classes. We also discuss the fit of ILS products in investment portfolios, including the economic value impact they could have on insurers.

Chapter 8 concludes with a review of growth potential and the associated implications for the ILS class. We discuss the growth prospects of each of the main ILS products. Importantly, we discuss the impact of ILS growth on reinsurers and what this may mean for pricing and cyclicality of the reinsurance market.