31 July 2013 Alternative Risk Transfer

New perils are needed if ILS is to grow

Capital market investors accessing the reinsurance sector through insurance linked securities (ILS) will have to accept a growing pool of new perils and ever more flexible terms and conditions if the market is to continue to grow at the pace it has in recent years.

That was a key conclusion of a report by Willis Capital Markets & Advisory called ILS Market Update: The Storm Before the Calm. The report also noted that as deals do become more complex in their structures and terms and conditions, it is important that a high level of transparency is maintained as one bad deal could tarnish the entire market.

“To continue the same pace of growth we have seen in the last few years across cat bonds and collateralized re, sponsors will need to deliver and investors will need to accept a growing pool of perils,” the report said.

“Some of these are evolutionary and not revolutionary, think earthquake risk in places like Columbia, Chile, Israel and even China. Others may represent a more radical departure from market norms. For example, will investors accept standalone US terrorism risk if TRIPRA is non-renewed? Will casualty risk finally become more at home in the capital markets?”

On terms and conditions, the report said that along with a rapid decrease in spreads in the last few quarters, terms and conditions have become increasingly flexible with some deals even having “name your own reset” provisions allowing firms to change the risk-return profile (within a range) on an annual basis.

“To some extent investors can price for these changes and should even welcome them if they bring more sponsors and deals to the market. This is particularly true if the high standards for transparency in both structure and collateral mechanisms that followed the financial crisis remain in place. On the other hand, a few bad apples (or sloppily structured deals) can spoil things as investors will assume that deals have hidden time bombs and price all new deals accordingly,” the report warned.

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