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September 2012 Bermuda Re/insurance


of comfort, that there is transparency around the risk and that the structures have been built in a fair and equitable manner”.


Wightman similarly argued that the structuring of these products is “pretty fundamental”. He said that in recent years ILS products have become more standardised and that “as you get more of them and people get better practised at delivering them” their popularity has grown. “The more you do these products, the more efficient, transparent and simpler they become. The capital markets are looking for efficiency—not complexity and large costs—so structuring for the capital market investor is important.”


Addressing the essentials of structuring the ILS product, Schultz said that there were two very important nuances to structuring— one that is client-centric, the other that is investor driven. On the client side, “the product has to respond to the underlying risk portfolio as much as possible, whether that is through indemnity structures or a highly structured deal that minimises basis risk to client. As we increase penetration of these products, we have to adequately answer this question.” On the investor side, Schultz said that transparency would be key, with capabilities on the underwriting and modelling side helping to instil further confidence in the ILS product.


products “often more than offsets any erosion in the traditional book, and is still value accretive” for traditional players. Reinsurers look set to increase their involvement in the ILS space. To do otherwise would seem like missing the train. Furthermore, Wightman added, “I would expect the broader reinsurance market to continue to do what it does best, namely in pushing the frontiers of risk transfer, reinsuring risks that traditionally they did not or could not do before, while exploring the huge growth potential in the emerging markets, whether that be through risk transfer or risk financing deals.


Structuring the fundamentals


One of the most important elements of ILS is the structuring of the product. Ease of understanding and the availability of appropriate data are central to the success of the sector. As David made clear, “structuring is critical—the disclosure and description of risk provides the ability to trade risk in a rational manner. Without a good description of risk, the trading of it between unequal partners vis-a-vis their knowledge of the data is difficult”. He said that modelling and models provide the basis for that understanding and that they therefore play a crucial role in the creation and transparency of ILS products. “Eqecat feels the role of the modelling agent is to be a neutral adviser and describer of the transaction,” said David. Schultz concurred that the “structuring and transparency on these deals is critical”. He said that as new investors enter the ILS market, they are looking for a “high degree


Wightman likewise spoke of the need for “better risk insight”. He said that a lack of information had always been a challenge to effective underwriting in the ILS space, but that as data knowledge improves, so investor and sponsor confidence will rise. “Simplicity will be key to this,” he said. Wightman said that the industry needs to create products that are ultimately attractive to the capital markets. The speed that ratings are provided today has helped, he said, as has the general regulation of these products, meaning it is now far easier for investors to “get their hands around these products”. Wightman said that investors are looking for “diversification, yield, speed to market, efficiency of product and transparency.” The modern ILS market is increasingly meeting these needs.


David concluded that with ILS products traditionally trading out on the tail, there were four characteristics for structuring that need to be borne in mind. The first of these is “robust modelling of the tail—these are low probability-high severity events and it is essential that the models capture both black swan events” and less catastrophic exposures. Second, models must include a “stable representation of the temporal constraints of the bond” so that there is no confusion regarding its application and trigger. Third, the ILS market needs to be able to handle and extend to clients a range of trigger types and features in order to provide depth and optionality to the market. Finally, the ILS space needs to show its ability to evolve to market conditions and demand, particularly as regards the disclosure of risk.


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