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How can ILS help to close the insurance gap, asks Clive O’Connell, partner, head of insurance and reinsurance at McCarthy Denning.

ILS is complementary to insurance and not its rival. ILS provides solvency protection to insurers and reinsurers, giving peace of mind to regulators and policyholders. ILS can now step further and, in helping to close the insurance gap, can help develop insurance markets.

Last year’s hurricanes have increased investment funds available to ILS. This money needs to be deployed in a diverse risk pool. At the same time governments are becoming aware of how ILS can help deal with the impact of natural catastrophes in areas where insurance penetration is very low. Instead of relying on growth of the insurance sector from the bottom up, a top down approach, in which governments purchase ILS products to guard against the economic and social disturbances of natural disasters, is taking hold.

Governments in some countries are appreciating that by using ILS, they can quickly restore damaged areas and keep local economies vibrant and can also spread the cost of such rehabilitation over a number of fiscal years. Similarly, governments of more economically developed nations have seen that purchasing ILS products for a number of nations as part of developmental aid can be more effective than providing disaster relief once a catastrophe has struck.

ILS, through these uses, provides the benefit of diversity to investors and broader and more certain protection to governments. Clearly, as there is no indemnity and as receipt of funds will be urgent, parametric triggers are, in reality, the only triggers available as well as being the only modellable way of pricing the products.

An additional benefit of using ILS to protect governments and to help to provide protection where insurance penetration is very low, is that it provides an encouragement to the government to close the insurance protection gap. It provides a stimulus to governments to encourage the development of insurance markets and an insurance buying culture. Clearly, as macroeconomic demands are such that disaster relief must come, through reinsurance, from the international markets, the growth of insurance stimulated by governmentally purchased ILS products, should lead to growth and diversity of risk for the insurance and reinsurance markets of the world.

ILS could be a factor in helping insurance grow in untapped markets rather than competing with itself in mature ones.

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