by ~ Jessica H. Park (Email) (Web Site)
The morning’s insurance-linked securities (ILS) theme continued with an engaging discussion of ILS trends by panel members John Seo of Fermat Capital Management LLC, Judith Klugman, of Swiss Re Capital Markets Corporation, Sean McCarty of Aon Securities Inc., and moderator Elaine Caprio of Caprio Consulting LLC. The distinguished panelists provided the audience with an informative and thought-provoking look at the evolution of ILS products and their potential impact on more traditional reinsurance markets.
As a baseline, the panel gave a helpful recap of the most commonly-seen types of ILS products: indemnity, index, and parametric bonds. Indemnity bonds, the panel noted, will fit into a company’s reinsurance layers and respond when the company’s loss exceeds a given amount, more akin to traditional reinsurance. Index bonds, in contrast, are triggered when industry-wide losses reach a particular threshold, as determined by designated reporting agencies. Finally, parametric bonds are triggered based on the physical parameters of an event, such as particular wind speeds or water levels associated with a storm.
ILS in general, it was noted, is an asset class that was initially slow to gain traction. During the financial crisis of the later 2000s, however, ILS held up quite robustly, thus becoming established as a helpful tool for ILS sponsors seeking catastrophe risk protection as well as an asset class useful for diversifying investors’ portfolios and providing an attractive return. For sponsors, ILS products provide multi year, fully collateralized protection against catastrophic events at spreads that are competitive with traditional reinsurance protection and pricing. As a result, the number of ILS issuances have grown, the number of ILS investors has gone up exponentially, and a greater variety of investors are showing interest in the bonds. Mutual funds, for example, have shown more willingness to invest in ILS, in contrast to earlier years when the assets were avoided because they were viewed as too risky.
As the asset class has gained popularity, the features of the bonds have also continued to evolve. The panel explained that early on, ILS products tended to be parametric in nature and were fairly basic. In response to ILS sponsor requirements, indemnity bond issuances have increased, and indemnity bonds now comprise the majority of the market. One panelist predicted, however, that the pendulum may begin to swing back and that more ILS sponsors will again explore parametric and index bonds as alternative coverage to indemnity-based bonds or reinsurance.
The panel also noted that more tailored and varied products are being seen in the ILS market. Sponsors can customize the attributes of a bond to meet their needs. Sponsors, ILS fund managers, and investors may choose to reduce some of the complex steps typically involved in a bond issuance, such as eliminating some of the modeling that might ordinarily be done prior to issuance. Streamlining ILS products in this way can help to reduce costs and shorten transaction times. The panelists noted that other types of alternative capital products are also on the rise, including collateralized reinsurance, industry loss warranties, and private catastrophe bonds (which also can be capable of very quick issuance – perhaps in as short a period as 10 days).
This evolution has, of course, had an influence on the traditional reinsurance market. It was noted that the market competition created by the popularity of ILS products has had a number of discernable effects, including a significant drop in reinsurance pricing and an expansion of the scope of some traditional reinsurance programs as more types of coverages are offered (e.g., terrorism coverage at relatively low costs). Another notable shift has been the increase in availability of multi-year reinsurance products, as opposed to cover available solely on a single-year basis. In that regard, the panel observed that indemnity bonds, in particular, have increasingly come toward a point of convergence with traditional reinsurance in recent years – not only have the bonds more closely come to resemble traditional reinsurance products, but reinsurance products, too, have taken on some features of indemnity bonds, such as multi-year offerings.
The panel’s discussion, overall, treated Symposium attendees to a fascinating look at a type of transaction which was relatively new to many in the audience, but which is clearly having a significant impact on many aspects of the traditional reinsurance market and seems likely to continue to do so as the market and ILS products further evolve.
Ms. Park is an associate at Sugarman, Rogers, Barshak & Cohen, P.C. She may be reached at park@srbc.com.
The 2015 MReBA Symposium presentations were for educational purposes only. Views expressed by panelists at the Symposium were their own and did not represent the views of their respective companies, law firms, or clients, nor do they represent the views of Sugarman, Rogers, Barshak & Cohen, P.C.
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