Is there an upper limit to the global market for insurance-linked securities (ILS)? Unsurprisingly, opinions in the insurance and reinsurance industry cover the entire spectrum. At one extreme are those who see catastrophe bonds and other ILS as complements to traditional risk transfer. At the other are those who believe the ILS market could exceed $50 billion in a few years. Right now, neither side can claim victory: The ILS market is still too young. Its future will depend largely on decisions made today about how to structure the transactions.
And when it comes to structures, once again, the spectrum has two ends: customized transactions and standardized ones.
Highly customized transactions can make it easier for sponsors to manage their risk and capital closely. But specificity comes at a cost, in terms of both structuring and selling the bonds. Much of the market’s future will depend on the willingness of investors to commit their capital to it. Highly customized deals may not fit as closely with an investor’s objectives, and the review process takes longer. In fact, in a recent report, PwC found that one of the key barriers to ILS market growth is product complexity.
On the other hand, standardized transactions may leave some gaps in cover, but sponsors can complete them faster and at a lower cost. Standardization makes it easier for investors to understand what the sponsors are offering.
The need for standardization is among the reasons why sponsors have remained committed to industry- loss-index triggers, despite speculation several years ago about the rise of indemnity triggers.
Because indemnity triggers are based on sponsors’ actual losses, sponsors like them. But such triggers expose investors to early triggering through the accumulation of losses in years of higher-frequency and lower-severity catastrophes. And because the triggers can vary from one deal to the next, the review process requires more time and effort.
Industry-loss-index triggers — such as the PCS Catastrophe Loss Index — make the process much smoother for investors.
Future growth in the catastrophe bond market will depend on the ease with which the parties can structure, review, understand, and complete transactions. The PCS Catastrophe Loss Index provides standardization that both sponsors and investors can use to make this form of risk transfer more effective. Of course, many factors will help determine whether the catastrophe bond market will reach $50 billion in capital outstanding. Trigger structure will be an important one.
For more insights into the catastrophe bond market, read the latest PCS Catastrophe Bond Report.