By Vivek Syal, Director, Insurance, PwC with co-author Marta Abramska, Principal Consultant, PwC
But other than recognising ILS as a way to mitigate risk which is equivalent to reinsurance, has preparation for Solvency II put enough emphasis on understanding the differences between reinsurance and ILS, and drivers of risk in the latter?
According to the ILS market veteran Michael Millette, insurance risks ceded to alternative investors are likely to more than double to $150 billion by 2020. But growth is not only about the size of the market, it is perhaps predominantly about the depth of penetration: ILS is increasingly covering risks that were unthought-of a few years ago when it was focussed solely on peak property cat; it now also allows sponsors to cede less modelled risk like marine, energy or personal accident lines of business.
Top ILS managers who put money to work on behalf of pensions and other end investors are sophisticated in the way they think about this risk – they also employ some of the top industry talent. Insurers and reinsurers who sponsor these deals are able to do so through a variety of instruments: public catastrophe bonds are most known, but collateralised private transactions between two parties are in fact more common. While excess of loss transactions dominated in the past, cedants are increasingly opening their books to the scrutiny of ILS funds and entering into quota share agreements.
Against the backdrop of a once esoteric market now becoming mainstream, insurers and reinsurers in the UK and Europe have spent the last few years preparing for Solvency II, and working hard in order to demonstrate to the regulator that they have an adequate understanding and control over risks that their business is exposed to. When I reflect on the past years, it strikes me how little those two significant market driving forces have been entwined on their paths. With the new regulatory regime around the corner, it remains unclear what impact is it going to have on the developments in the ILS market. With the exception of new offshore domiciles seeking to win market share from ‘established’ domiciles through the promise of Solvency II compliance, tax efficiency and facilitated transaction set up, the two topics have been brought together surprisingly little.
In my mind the questions that (re)insurers should be really asking themselves when considering the efficiency their ILS deal as a risk mitigation technique and communicating to management are:
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Under which circumstances the transaction will not provide adequate protection in an aftermath of an event? Non-indemnity transactions come with different degrees of basis risk, depending on the trigger mechanism, which should be explored and tested to avoid potential surprises.
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How watertight is the event definition? Any ambiguity in how the payout event is defined increases the risk of litigation, as the Mariah Re catastrophe bond experience has taught us.
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How wrong could the model used to assess the totality of the risk be? Do you have a full understanding of what is covered, not covered or not sufficiently covered and therefore what mitigation actions you need to consider?
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Has your deal positively influenced your risk profile and how has this been measured?
With George Osborne announcing the desire to place the UK on the ILS world map on 18th March, there is clearly a growing opportunity for insurers and regulators to lead the way in this innovative market.
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