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Areas below the leverage

latitude line

tend to capitalise


obligations in full. All of the new islands are below that line and there exist several distinguishable zones in these southerly latitudes. The first is the ‘ratable’ latitude line. Any opportunities existing below this line are likely to have an agency rating. There is yet another latitude line further south where opportunities in this zone are likely to be rated ‘investment grade’.

Notice that the arrangement of latitudinal zones is such that the further

north one goes, the more return can be expected, but equally travelling further north also brings with it higher risk and/or volatility of return. See both vertical axes for these notations.

With our framework in place, we are ready to explore the islands

themselves. Starting in the west, the Big Deal island represents the traditional way

of accessing nat cat. It involves investing in the equity of a reinsurance or insurance company. Like its counterparts in the North Atlantic and Caribbean (Great Britain, Grand Bahamas and Grand Cayman), the Big Deal island is where franchises and protection have carried on for many years. The names of those protectors are well known and include Munich Re, Swiss Re, Lloyd’s, Axa and Berkshire Hathaway.

Newer companies also exist on this island—Renaissance Re, Allied,

Transatlantic Re, Aspen, etc. So too do the ghosts of past companies— Mid-Ocean, Cat Re, IPC Re and PXRE. The presence of new companies, worthy old companies and the vestiges of dead companies tells its own story for those who wish to read it. There is movement here. Indeed, it is rumoured that some of these companies used to have offices in the best investment grade regions, but that appears to be in another era.

While these Big Deal companies do provide access to nat cat risk, that is not all they provide. Investors may buy into other lines of insurance, legacy risks and into substantial investment risk, increasing correlation to other markets. It is hard to get a pure nat cat play on Big Deal island.

Immediately south and east of Big Deal island is Sidecar island. On this island, they try to get such pure plays. When the time is right, ie, when the Big Deal players need extra temporary capital to cover more nat cat risk, they may carve out a share of their nat cat underwritings and cede it to the investor for a limited period of time. The investor is alongside the parent for that fixed period.

He will enjoy exactly similar returns to the parent, except for fees (management and performance fees as in a hedge fund) and any disputed exit valuations. Returns could also diverge if the parent reinsured itself without dittoing the sidecar. Long-term examples are rare, but Da Vinci, associated with Renaissance Re, is one such sidecar. Essentially, Da Vinci investors put themselves in the hands of the underwriters at Renaissance, but only for specified and contracted nat cat risks.

Travelling further east are two ILS islands. ILS stands for insurance linked

securities, also known as cat bonds. These are the islands that have created so much attention in the last few years. The opportunities emanating from

Morton N. Lane PhD is the president of Lane Financial. He can be contacted at: For more details, please visit

October 2011 | INTELLIGENT INSURER | 41

ILS are a) pure nat cat plays, and b) known and declared specific risk and with known maturities. These deals are as close to corporate bonds as you can get in the nat cat world.

Almost $40 billion of the bonds from these two have been issued

in the past 12 years. Notice that there are in fact two islands that are intimately attached to each other (not unlike North and South Island in New Zealand). The distinction between the two is that they straddle the indemnity longitudinal line. The first island is the source of indemnity- based ILS and hence has an ‘extension of maturity’ risk associated with it. The other island is the source of index-based risk. These ILS are much in demand by investors, although there is a tension with issuers who prefer the extra security of no-basis risk that they get with indemnity issue.

Investors wanting to access these ILS can acquire the ILS when issued,

or they can engage hedge fund professionals to accumulate the correct composition of ILS for their portfolio and manage the rest on their behalf.

In recent years, the money flowing to hedge funds has outweighed

the supply of ILS. Hedge fund managers have come up with several different ways of accessing pure nat cat risk. The most recent, and one that is likely to get even bigger, is the one that lies directly between Sidecar and ILS: collateralised ILS. In these transactions, the specific pure play nat cat risk is identified, but instead of being cast as a bond, the investment is left as a swap transaction against a traditional reinsurance cover.

The investing entity does not have to be a traditional reinsurer from Big

Deal island, but it may have someone to ‘front’ for its swap. The ‘fronter’ is made financially comfortable by securing collateral from the investor as acceptable security. This way the investment return stays with the investor; the pure protection play also stays with the investor. Collateralised ILS can be club deals or syndicated.

One other line of islands is displayed on our schematic—the ILW islands. ILW stands for industry loss warranties. Much like collateralised deals, the ILW refer to specific risks, but are denominated in an ‘industry’ loss measure. These include industry indices from PCS in the US and PERILs in Europe. Notice that a new island in the group is called CWIL ILW. These are county-weighted industry loss measures. They have become very popular in recent months and have begun to take the place of traditional ILWs.

There is another island at the eastern-most part of the archipelago. It

shows ILS that are based on mortality risk rather than specific nat cat. Other islands pop up occasionally that are not shown at this resolution— ILS based on auto, excess liability and longevity/mortality. These will become even more evident as time passes.

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