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28 September 2017 Alternative Risk Transfer

Proof of the ILS pudding

In 1992, Hurricane Andrew was the catalyst behind the development of insurance-linked securities (ILS). In 2005, hurricanes Katrina, Rita and Wilma led to the growth and use of ILS solutions. Now, in 2017, hurricanes Harvey and Irma could drive the development of ILS beyond the Gulf of Mexico and US Atlantic coast, and possibly beyond the realm of natural catastrophe.

The recent storms show the use and effectiveness of ILS as a protection product. The insurance and reinsurance industry has been insulated from the significant losses caused by these almost unprecedented storms by alternative capital invested through ILS products. Regulators will look on in the comfortable knowledge that insurers and reinsurers are sufficiently solvent to meet losses at unprecedented levels with little concern about failures. Risk-based capital regimes and the use of ILS within them, have done their jobs.

This proof of the effectiveness of ILS must not go unnoticed by regulators and CFOs. What can assist companies with unexpectedly high losses from natural catastrophes in the Gulf of Mexico, can also help companies facing potential unexpected losses elsewhere in the world and in other risk classes. A truly robust insurance market is one backed by ILS.

Investors should also look at the events of the past few weeks and consider how their ILS strategy needs to develop. While some commentators have suggested that significant cat bond losses might give rise to a retreat from the sector, that view ignores the sophistication of the investors concerned. ILS investors came to the market with their eyes wide open. They knew and understood the risks. They are also aware that the hit that they are now taking will result in better returns in the future.

ILS is a diverse investment opportunity and it remains so. The question that exists for ILS investors is whether the concentration of ILS products in one geographic area and one class of business gives the necessary diversity within that already diverse investment class. The answer is that if other ILS investment opportunities present themselves, greater diversity can be achieved and ILS investors can spread their risk and allow for more sustainable returns.

In other words, the recent devastating storms present a golden opportunity for both insurers and reinsurers and for investors to diversify the range of ILS products available by class and geography.

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