In general, Property Claim Services® (PCS®) doesn’t have an opinion as to which catastrophe bond trigger is best. We believe sponsors should use the structures they feel align best with their risk and capital management strategies. However, as the leading provider of index services to the global insurance-linked securities (ILS) community, we’ve had the opportunity to understand the benefits that sponsors realize when using the PCS Catastrophe Loss Index for catastrophe bonds covering the United States and Canada.
Five key advantages to using an index trigger are:
1. Efficiency: Index triggers are easy to understand. There’s a single, easy-to-use source of data for industrywide catastrophe loss estimates. In contrast, with an indemnity trigger, the sponsor needs to gather and review its catastrophe claims, and disagreements may arise as to whether to include some claims.
2. Analysis: Indemnity-triggered catastrophe bonds require investors to understand a sponsor‘s underwriting philosophy and claim-handling practices. That analysis creates more work up front (and an inherent soft frictional cost). Index-triggered transactions do not require such intimate knowledge of the sponsor’s operation. That can make it easier for a sponsor to engage some investors.
3. Security of proprietary information: In addition to facilitating investor analysis, index triggers allow sponsors to protect proprietary information, as examinations of underwriting practices and claims operations become unnecessary. As a result, sponsors can protect what they believe are competitive advantages.
4. Data quality: The quality of a sponsor’s internal data is not an issue when using an index trigger. With an index trigger, a sponsor can access the capital markets without regard to how it collects, stores, and reports on internal data.
5. Lower costs: While there’s a cost to use an index, a number of factors may offset that cost. Sponsors may get a lower overall cost of capital (depending on data quality, market conditions, and other considerations). Also, when an event is of a size to trigger a catastrophe bond, settlement can proceed faster — and likely with less risk of dispute.