(Re-) Insurance linked investments 

Executive summary

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


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.





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