TO DOWNLOAD THIS SUMMARY IN PDF FORMAT PLEASE CLICK HERE
(Re-) Insurance linked investments
That type of investments (known as «ILS») can offer attractive returns for a simple reason: Insurers are willing to pay substantial premiums to hedge and spread the risk of a major, but unlikely, catastrophe that could jeopardize their continued survival. Investors on the other hand are in a position to take on this risk, therefore work with pure insurance risk unlike insurance debt / equity which bundles insurance risk with operational, credit, market, and other risks.
ILS market allows buyers to acquire attractively priced, significant, secure, dedicated, protection while affording investors unique opportunity to participate in a totally uncorrelated asset class with attractive returns relative to instruments of similar rating/ risk profile.
Protection buyers (risk-exposed entities) and protection sellers (investors) use rapidly growing ILS market to facilitate hedging, investment, and trading of a broad spectrum of worldwide insurance risks.
Global natural catastrophe risk, at the moment, remains the most actively transacted risk in the ILS market. Although many programs have regional or even particular country focus with different insured events triggers (As an example: USA All Natural Perils, US Florida Wind, Japan Earthquake, European Storm, etc.)
ILS market has steadily grown from its origins in mid-1990’s to an estimated $60bn market today, and is projected to triple in size by 2020. Goldman Sachs has recently identified ILS market, also known as “alternative insurance capital”, as “disruptive force” responsible for a seismic shift in how insurance risk is being financed.
Investors in ILS market comprise global public and private pension funds, asset managers, hedge funds, family offices and high-net worth individuals. Interestingly that as uncorrelated asset this is common now for allocation of 5-6% of AUM (Assets Under Management) to be invested in ILS as the way of diversification for custodians of massive pension funds.
Investment opportunities within the ILS asset class comprise 4 main types of transactions: Retrocession, ILWs (Industry Loss Warranties), Cat Bonds & Sidecars. Here is a brief description of each:
1) Retrocession (Collateralized reinsurance):
When insurer protecting its peak exposure to major catastrophe on top of certain self-retention (Excess of Loss reinsurance). These programs have trigger known as UNL (Ultimate Net Loss) and very straightforward deals with one-year maturity and premium payment upfront or bi-annually.
Provided there is no loss investor, who already had its premium, released from collateral, which is done either in a form of Standby Letter of Credit or Collateral Trust Agreement with approved bank.
The most risk concentrated but rewarding type of transactions. Usual range of gross premiums 25-35%, which means net to investors return at around 23-27%.
Sample deal: Property portfolio reinsurance of XYZ company for UNL in excess of 30 million. for Gross rate on line of 30%
2) Industry Loss Warranties (ILW):
Similar to retrocession with the difference that the trigger for the event is the loss to the industry as a result of major catastrophe. Loss to the industry is based on the index provided by specialist organisations predominantly being: PCS (US), PERILS (Europe) or SIGMA (Worldwide). Also based on annual tenor with similar protocols for premium payment and collateral release.
Gross premiums for such deals are in a region of 15-25%, i.e. around 12-20% net to investor.
For ease of use here is a good chart on ILW pricing by some industry colleagues:
Sample deal: Reinsurance of XYZ company for US All Natural Perils catastrophe loss in case industry loss exceeds USD 5 bln. Based on PCS ANP index
3) Catastrophe Bonds (Insurance Linked Securities):
The way of transferring risk from insurance to capital market through sponsorship and issuance of securities known as Catastrophe Bond. These are OTC traded securities with 3 years maturity but contrary to other forms of ILS they have immediate liquidity. Interest calculated and paid monthly.
Average interest is about 8-12% p.a., paid monthly.
Explanation of Catastrophe (CAT) Bonds
Sample deal: Turkish CAT Pool issues “Bosphorus” bond covering earthquake event in the country.
4) Sidecars (Quota shares):
Pure investment of capital into the business of particular insurer whereby investor totally “follow the fortune” of the designated partner and performance of portfolio of the company. This is not yet equity investment but closest way of cooperation with insurer requiring significant knowledge of insurance business. In fact can be described as funds given to insurer “to play with” in respect of designated class of business. Usually used by insurers from other regions to enter Lloyd’s market through provision of capital into Lloyd’s syndicate. Profitability for investor depends on profitability of the portfolio and can vary from 20% return on capital to negative result.
Sample deal: Entrance into the Lloyd’s market by China Re through Quota Share arrangement with Catlin. Eventually led to set up of separate Syndicate for China Re at Lloyd’s after 3 years of cooperation with Catlin.
Sidecars: a strategic market play
ORIGINAL PUBLICATION HERE
As the use of sidecars and third party capital initiatives continues to accelerate, Intelligent ILS takes a look at how the traditional sidecar is being adapted to facilitate different forms of alternative capital, and examines how this form of risk transfer is becoming an increasingly important strategic tool for reinsurers.
Phoenix CRetro Reinsurance Company (“Phoenix CRetro”) is authorised and regulated by Bermuda Monetary Authority pursuant to Insurance Act 1978 and Segregated Accounts Companies Act 2000 of Bermuda.
This document is solely for your use (“you”). The concepts and structures it contains are confidential and proprietary information, as well as business assets of Phoenix CRetro and our affiliates (“PHCRE”, “us” or “we”). They are shared with you for the exclusive purpose of allowing you to evaluate your interest in such structures. In particular, this information may not be used to discuss similar structures with any person PHCRE could reasonably consider a competitor in this field. Unless otherwise agreed in writing, PHCRE and its affiliates act solely in the capacity of an arm’s length contractual counterparty and not as an adviser or fiduciary. Accordingly, you should not regard transaction proposals or other written or oral communications from us as a recommendation or advice that a transaction is appropriate for you or meets your financial objectives.
Any financial transaction involves a variety of potentially significant risks and issues. Before entering into any financial transaction, you should ensure that you fully understand the terms, have evaluated the risks and determined that the transaction is appropriate for you in all respects. If you believe that you need assistance, you should consult appropriate advisers before entering into the transaction. PHCRE does not provide accounting, tax or legal advice. In addition, we agree that, subject to applicable law, you may disclose any and all aspects of any potential transaction or structure described herein that are necessary to support any U.S. federal income tax benefits, without PHCRE imposing limitation of any kind. This material does not constitute an offer to enter into any transaction. Such material is believed by us to be reliable, but we make no representation as to its accuracy or completeness. This brief statement does not purport to describe all of the risks associated with financial transactions and should not be construed as advice to you.
Certain aspects of this presentation may give rise to perceived or actual conflicts of interest (i) between you and us and/or (ii) among you, us and other third parties. Such conflicts may arise from other business activities customarily conducted by other areas of our firm with you or with other clients. Such activities may include, but are not limited to, sales and trading activities. For example, we may already have executed similar transactions or strategies for our own account or accounts of other clients and we may have made similar presentations to others. Execution of any transaction contemplated in this presentation may involve other affiliates of PHCRE and may result in perceived or actual self-dealing intended to generate revenue for our firm. This document is for information purposes only and does not constitute an invitation or inducement or an offer or commitment, a solicitation of an offer or commitment, or any advice or recommendation, to conclude any transaction. While information herein has been obtained from sources believed to be reliable, we do not represent it to be accurate or complete. The information contained herein includes illustrations, estimates and projections and involves significant elements of subjective judgment, assumptions and analysis. Any views or opinions (including illustrations, estimates, statements or forecasts) constitute our judgment as of the date indicated and are subject to change without notice. No representation is made as to the accuracy of such illustrations, estimates or projections or that all assumptions relating to them have been considered or stated or that such projections or returns will be realised. The returns or performance results may be lower than estimated herein. Note that past performance is not indicative of future results. The information contained herein does not purport to contain all of the information that may be required to evaluate such solutions and you are encouraged to conduct independent analysis of the data referred to herein. We do not undertake to update this document.