ILS
Table 1: Characteristics Of Product Offerings Through Which Alternative Capital Has Accessed Insurance Risks
Publicly traded cat bond
• Tradable • Pricing publicly available • Most-liquid ILS instrument • Requires independent risk analysis • Majority rated • Investor receives quarterly coupon payment (premium payment from cedent + yield from collateral)
• Usually provides multiyear protection with reset mechanism • No reinstatement after loss • Predefined collateral-release mechanism
Privately placed cat bond (limited to certain investors)
• Higher frictional transaction costs for sponsors • Provides coverage to cedent on predefined event parametrics, industry losses, or actual cedent loss
• Tradable but only among a limited number of investors • Investor receives quarterly coupon payment • Limited liquidity • No requirement for independent risk analysis • Usually issued in amounts less than $50 million • Provides coverage to cedent on predefined event parametrics, industry losses, or actual cedent loss
• Usually provides multiyear protection • No reinstatement after loss • Predefined collateral-release mechanism
Cat bond lite (collateralized reinsurance in bond format)
• Eligible investment for ILS funds • Faster time to market • No requirement for independent risk analysis • No rating requirement • Tradable • Limited liquidity • Can be structured to provide reinstatement • Concern that assets in segregated cell could be caught up in bankruptcy of holding company
• Provides coverage to cedent on industry losses or actual losses • Annual renewal
Collateralized reinsurance (over-the-counter derivative structure)
• Not tradable • Can be customized to meet cedent’s and investors’ needs • Access to full reinsurance submission information • Uses insurance documentation with collateral release section similar to cat bond documentation
• Premium payments are made into the collateral trusts either up-front or periodically
Traditional reinsurance
and the alternative market but also among alternative capital-market participants themselves. Specialized ILS funds are driving some of this competition. These funds are set up so their managers can employ their assets under management using whatever reinsurance arrangement permits them to provide protection to cedents while earning the maximum return. Some fund managers also take on reinsurance risk and transform it into more-liquid cat bonds so that their funds can invest in them. Others aim to invest in tradable cat bonds only. As the increase in supply pushes down yields, specialist ILS fund managers have set up new funds with lower targets to employ their available capital at current pricing levels and continue to compete under current market conditions. This could mean that without a major catastrophe event, pressure on nat cat prices could continue.
• Collateral posted equals the full reinsurance limit less the net premiums charged for the protection
• Allows risk takers to underwrite insurance risk without a financial strength rating • Provides coverage to cedent based on actual losses • Annual renewal
• Not tradable • Not collateralized - depends on financial strength of reinsurer • Investor borrows financial strength from a rated reinsurer through transformer vehicles
• Typically offered for a term of one year with reinstatement after an event • Typically more flexible terms and conditions • Access to full reinsurance submission information • Long-term relationships between cedent and insurers are important • Provides coverage based on actual losses of ceding company • Annual renewal
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In the first half of this year, pricing continued to drop for issuers as did yields for investors. On a weighted average basis, the risk spread on transactions that we rated paid to noteholders was 5.44%. The range was from 2% to 7.5%. The interest spread as a multiple of expected loss decreased as well. On a weighted average basis, this multiple was 3.38x and ranged from 2.97x to 4.17x. The weighted average net expected return (risk spread minus expected loss) was 3.79% and ranged from 1.48% to 5.20%. Included in these totals is the $1.5 billion Everglades Re issuance, which is the biggest issuance amount for any one transaction to date and skews the results. If we were to exclude this transaction, the weighted average risk spread would decrease to 3.57% and the weighted average net expected return would decrease to 2.52%. The interest spread as a multiple of expected loss would increase to 3.49x (see Chart 3). All these figures exclude the Vitality Re V Ltd. issuance. According to Willis Capital Markets & Advisory (“ILS Market update – Declining Spreads & Flexibility in Structuring” April 2014), specialized ILS funds increased their participation in “cat bond lite” transactions and collateralized reinsurance to avoid the competition from publicly traded cat bonds. The advantage of these private placements for investors is that they can preempt a cat bond placement that would have been syndicated and issued at a lower spread. However, as Willis noted, sponsors now understand that even with the frictional cost (costs associated with issuing a cat bond such as legal, modeling, and rating agency) of a
Global Reinsurance Highlights 2014
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