ILS: pricing, diversification and illiquidity premium

21-04-2016

ILS: pricing, diversification and illiquidity premium

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Roman Muraviev, head of cat bonds, and Sandro Kriesch, head of private ILS, at specialist insurance investment manager Twelve Capital, take a look at recent pricing developments.

Some 20 years ago, Morton Lane and John Finn depicted the right price for an insurance risk as one “where the perfume of the premium overcomes the pong of the peril”. While there are numerous fair valuation paradigms in the re/insurance sector, which can vary from option pricing techniques to actuarial loading principles, one aspect remains somewhat identical among all theories, namely that the ‘pong of the peril’ should be quantified by considering an appropriate capturing of the loss distribution of the respective risks.

However, it seems that at least some segments within the 144A cat bond market generally tend to consider only one factor when pricing transactions, the ‘expected loss’ of the transaction rather than the entire loss distribution. Indeed, when considering all publicly launched cat bonds focusing on Florida hurricane risks since 2014, pricing closely tracked a linear regression of the coupon against the expected loss, as can be seen in Figure 1.

“The cat bond market offers opportunities to disciplined investors that can pick (and pan) transactions according to solid pricing techniques and fundamental convictions.”While this approach offers an insight with respect to pricing patterns, Twelve believes that solely relying on the ‘expected loss’ is insufficient, and as such the cat bond market offers opportunities to disciplined investors that can pick (and pan) transactions according to solid pricing techniques and fundamental convictions.


ILS, specialist insurance, pricing, diversity, illiquidity premium, insurance risk, Twelve Capital

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