Interest in Insurance Loss Warranties (ILWs) is at the highest level it has been since 2007, with a report from Willis Re anticipating that prices this year will equal those reached in the post hard re/insurance market which followed Hurricanes Katrina, Rita and Wilma.
2011 was a record year for natural catastrophe losses for the re/insurance industry, and a succession of individual events caused a number of pay-outs on ILW contracts, proving the instrument’s worth in a trying year for the industry, and triggering significant trading interest in ILWs for 2012.
What are ILWs?
For those uninitiated – an ILW is a type of reinsurance or derivative contract through which one party will purchase protection for an event, based on the total loss to the entire insurance industry rather than their own losses. Energy companies based in the Gulf of Mexico, for example, are investigating the use of ILWs to hedge the risk of big financial losses when hurricanes hits certain counties in Texas.
ILWs and catastrophe bonds are the most popular types of insurance-linked securities – investment vehicles that allow traditional insurers and reinsurers to transfer some of the catastrophe risk on their books to capital markets investors.
In recent years, the ILW has cemented itself as an integral part of a buyers exposure hedging strategy, and according to the Q1 Willis Re ILW update, around 75 percent of the estimated $6.5-7.5bn of 2012 ILW capacity traded will come from capital markets players including those that use a fronting reinsurer to support a collateralised cover (see bar chart below).
Diversity and Innovation
Henry Kingham, Executive Director, Willis Re Specialty and co-author of the Q1 2012 ILW update, says that the diversity of the ILW is appealing for investors. “At one extreme of the spectrum we may negotiate a highly structured, multi-year, $50m+ collateralised reinsurance deal as an ILW, while at the other end the smaller spot trade in a peril and territory that is very transparent – like a US Wind $50bn industry loss trigger – is still a standard trade.”
The report comments that buyer appetite also continues to drive innovation in contract design, with heightened interest in purchasing ILWs with aggregate trigger levels – rather than the standard one-shot single event trigger – and multi-peril triggers.
More buyers also sought to tailor their protection for 2012, in structured deals. Kingham comments: “We are increasingly seeing demand for structured deals that aim to minimise basis risk and are tailored to suit a buyer’s portfolio. This is matched by sellers looking to offer capacity that suits the buyer’s needs, but that still triggers on an industry loss estimate rather than the buyer’s own loss experience.”