The ripple effect of insurance-linked securities in the reinsurance market
Discover a place where the reinsurance and capital markets converge, where investors can receive reasonable returns and diversify risk while the reinsurance market may get access to capital and insurers may get access to coverage at a lower cost. This place is the insurance-linked securities (ILS) market.
Insurance-linked securities are key for insurers and reinsurers to thrive
According to the National Association of Insurance Commissioners (NAIC), insurance-linked securities (ILS) are securities whose performances are linked to the possible occurrence of pre-specified insurance risks. This expansion of what was originally called catastrophic bonds may at first glance seem to deter investors due to its lower level of return. The reality though is that insurance-linked securities offers some interest rate protection and therefor has great appeal for investors from both life and property/casualty insurers.
ILS issuance is on the rise, with steadily increasing demand showing proof of growing year-over-year. Even though the securitization market as a whole is down from the glory years before the financial downturn, ILS growth is still predicted. Investors are coming from all over the world as well. While the United States covers 59 percent of ILS buyers, Europe; Bermuda; and even a little investment action from Japan, Canada, and Australia are represented as buyer as well.
Growth may also be seen due to the change in climate, with many believing that the incidence of extreme weather events has increased in the recent past, from drought- and wind-driven fires to vicious storms and much in between. Earthquakes or hurricanes are not US-only events, and the expansion of ILS into these coverage areas may not only provide a societal good, but also enable ILS investors to geographically diversify their risks.
While the current supply exceeds demand, expanding existing markets or penetrating new ones,this may actually be both profitable and to the common good with the increasing availability of capital in the insurance sector. ILS issuances are concentrated around covering catastrophe risks, dominated by US perils. A very small percentage of issuances are covering mortality- and health-related risks.
But as with almost any relatively new product, there are concerns that need to be weighed against the potential benefits. Difficult tax distinctions that arise with regard to determining the tax treatment of ILS issuers and holders, tax accounting and income recognition rules, and the like. For example, is the business being conducted to be treated as insurance for tax purposes, or as a sort of financial product? Is there a US-sourced business being engaged in or is it purely “offshore?" Do ILS products, specifically cat bonds, constitute debt or equity for tax purposes, and how does that affect US reporting requirements? Additionally, the biggest regulatory fear is lack of capacity, followed by concern about pricing, both eventually trickling down to affect consumers. Transparency continues to be an issue of great interest to both regulators and investors.
Whatever happens with this particular proposed product, the takeaway might be that change is coming, and the future will belong to those who choose to let go of current orthodoxies and most effectively adapt their thinking and their business models.
Read our new report, Securing tomorrow: The ripple effect of insurance-linked securities in the reinsurance market.
What’s in the report
Securing tomorrow: The ripple effect of insurance-linked securities in the reinsurance market covers the following topics:
- New capital, new technology, new ways to reinsure risks
- History and evolution of insurance-linked securities (ILS)
- Growth outlook for ILS
- How new ILS coverage areas may affect demand
- US tax considerations related to ILS use and investment
- Increased transparency could broaden ILS market
- Design changes enhance ILS attractiveness
- Traditional market participants should embrace change