From: Captive Insurance Times
As capacity and capital concerns continue to upset the commercial market, industry professionals outline the advantages of the insurance-linked securities model, recent market diversification, and the relationship with captives
Insurance-linked securities (ILS) are financial instruments, such as derivatives or securities vehicles, whose value is influenced by a loss event underlying the insurance structure. Since value is linked to insurance-related, non-financial risk (such as natural catastrophes), ILS have a low correlation with the wider financial markets.
This provides a secure, collateralised form of funding dedicated to a specific risk, that requires coverage by acting as a mode of reinsurance for insurance entities.
This securitisation model was developed by the insurance industry in the 1990s to create an additional source of insurance and reinsurance capacity for hard-to-place property catastrophe risks, outlines Scott Cobon, executive vice president and head of insurance management at Artex.
This capacity was accessed by ceding risks directly to the larger, and mostly unbroached, capital markets rather than to a traditional reinsurer or retrocessionaire through traditional contracts. As such, ILS allow insurers and reinsurers to raise either capital or capacity while transferring risk.
Cobon continues: “Some risk-bearing entities were looking for interesting and unique ways to offload those risks, and they turned to the broader capital markets through securitisation. The markets then matured and developed over those preceding years.”
Adele Gale, group head of ILS at Robus, explains: “ILS provide capacity to insurers and an alternative market for protection buying. For investors, they are assets whose value is linked to the occurrence of an insured event, and are largely uncorrelated to equity markets.”
The ILS asset class encompasses catastrophe bonds, industry loss warranties, collateralised reinsurance products and other forms of risk-linked securitisation. Cat bonds create risk-linked securities that transfer a specific set of risks — usually related to catastrophe risks — from a ceding company to capital market investors.
Since ILS are not mutually associated with financial markets, the alternative asset class can provide investors with diversification benefits, as well as supporting humanitarian efforts, and the possibility of earning a return.