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than banking products, where the arrangers of transactions are commonly reinsurance brokers and where many of the investors act like, or actually are, reinsurance companies. This is a far cry from the vision of the capital markets practitioners who pioneered the sector and who envisaged truly non-aligned ILS capacity absorbing a wide spectrum of reinsurance risks. In order to understand why the ILS market has evolved as it has, as well as its potential for the future, we need to consider how it has been shaped by the events of recent years.


T The ILS sector experienced considerable and rapid growth in the middle


years of this decade, fuelled by the co-incidence of an ample supply of investor capital with the post-2005 hurricane season hard reinsurance market. During this time, cat bond issuance volumes hit highs in successive years, and new forms of private transaction, which became known as ‘collateralised reinsurance’, emerged in response to investor demand for a wider range of risks and risk profi les offering greater levels of potential return. Although not technically a ‘securities’ transaction, collateralised reinsurance is closely linked to the cat bond, in terms of what it achieves and the identity of the investors ultimately assuming the risk.


This ongoing expansion of the market was brought to a shuddering halt


by the onslaught of the 2008 fi nancial crisis. The revised perception of the creditworthiness of banks highlighted structural defi ciencies within the classic cat bond structure, which needed to be urgently addressed. Contemporaneously, many investors, hedge funds in particular, suffering the broader effects of reduced availability of leverage and the need to return cash to their own investors, withdrew from the ILS sector on a wholesale basis, often never to return.


A viable secondary market in cat bonds enabled hedge funds to monetise


their holdings in an orderly fashion without destroying market values. Dedicated ILS fund managers and reinsurance companies opportunistically bought bonds from the selling hedge funds at a discount, albeit less than that applicable to most other types of securities changing hands at that time. The market having thus been underpinned and structural problems resolved, cat bond issuance recommenced in early 2009 and has continued steadily since. Total issuance volumes during 2009 amounted to $3.4 billion—up on the total achieved in 2008—and 2010 issuance appears on course to increase further.


he underlying story of the insurance linked securities (ILS) market has unfolded in ways few would have predicted. Today, we fi nd a market whose products often appear more like reinsurance


November 2010 | INTELLIGENT INSURER | 39


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