30 January 2015 Alternative Risk Transfer

Secondary ILS market could generate price discounts

Increased trading in the secondary insurance-linked securities (ILS) market will offer many benefits to the reinsurance industry, such as a more detailed view of appropriate pricing.

Speaking to Intelligent Insurer, Rick Miller, co-head of ILS and Michael Popkin, managing director, co-head of ILS both at Jardine Lloyd Thompson Capital Markets; and Martin Davies, chief executive at AHJ Capital Markets spoke of the benefits to be gained from developing this market.

“If a true secondary market develops, it will generate a price discount for the liquid ILS versus the illiquid standard reinsurance contract. To some extent this already exists: many ILS funds are required to invest only in issues that can be traded and where there is a market price. Consequently, there is more demand for such securities and the price is driven down,” said Davies.

Popkin added that the pricing around secondary levels provides some guidance around where the price per risk is, which is visible to reinsurers and ILS managers, which is helpful and informative.

“If you’re a traditional market user and you’re coming to market once a year for your programme placement, and you’re able to observe intra-year where prices are moving, it’s going to give you some idea around what is the multiple required for a particular expected loss, given the mixture of perils,” he said.

“It’s providing market information about what the current yield requirement is for a given level of risk on a more frequent basis, so it is informative.”

Miller added: “As a traditional reinsurance player, you probably already have visibility on the capital markets’ view of risk. This may come from viewing things externally as an issuer of bonds. It may come from the perspective of a third party asset manager operating off your traditional reinsurance platform and running a portfolio of bonds. It’s helpful in terms of monitoring that because it will give you a directional perspective on a more granular level of where rates are going.”

Davies agreed with Miller and Popkin. He said: “Information gained from the secondary market tells us what the market thinks each ILS is worth at every point in its existence. A new security being traded at a premium—or a discount—tells us how effectively it was marketed and how we should approach the renewal.

“The market pricing of similar securities tells us better than any individual underwriter what the correct price for a risk should be if it is to be placed efficiently. This creates a feedback loop where secondary pricing drives primary underwriting.”

To read the full story on the Intelligent Insurer website, click here.

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