Kate Storey of Appleby's corporate and commercial team in Guernsey looks at the emerging alternative asset class of insurance linked securities.
Insurance linked securities (ILS) are growing as an alternative asset class for a diverse group of capital markets investors, including investment funds. Further, the sponsors of ILS products are showing increasing interest in Guernsey as the jurisdiction in which to establish their ILS structure (where Bermuda has traditionally dominated).
ILS products typically include catastrophe bonds (Cat bonds), industry loss warranties (ILWs) and sidecars. Cat bonds are risk-linked securities that transfer catastrophe risks to capital market investors. ILWs enable a purchaser to buy protection based on insurance industry losses arising from a specific event, rather than from the buyer's losses. Sidecars are special limited purpose (re)insurance companies which assume a portion of the ceding (re)insurer's underwriting risks (including losses and expenses) in exchange for a proportional share of the premium. ILS products typically cover natural catastrophes (hurricanes, earthquakes), life insurance (mortality and longevity) and man-made events (fire, terrorism, even lottery jackpot losses).
The sponsors of ILS products are (re)insurance companies, governments and companies who use ILS to transfer their (re)insurance risks to the capital markets, including specialist cat funds, hedge funds, private equity funds, pension funds, banks and (re)insurers.
ILS products are used by sponsors as an alternative risk management solution to achieve capital efficient and flexible underwriting capacity, finance growth and to spread the risk to the capital markets. In this way ILS have become a viable alternative to the traditional (re)insurance markets.
From the perspective of the investment funds which are increasingly investing in ILS, ILS offer a number of advantages over other asset classes, including:
- a diversifier largely uncorrelated with other major asset
classes and the general financial markets;
- comparatively high potential returns for investors through investment income on the investment in the ILS structure, together with premiums paid to the ILS structure to take on the risk, against low probability catastrophe or other insured events;
- comparatively short investment term, which offers a degree of liquidity - for example, Cat bonds are typically 12 months to 5 years;
- low credit risk of the (re)insurer counterparties.
As an example of an ILS sidecar transaction, Appleby Guernsey has recently advised a major global provider of alternative risk transfer services in relation to a collateralized marine reinsurance structure using a Guernsey special purpose vehicle reinsurance company as a sidecar, with investment fund investors effectively providing the collateral through preference share subscriptions into the structure.
Although the ILS in that transaction were not listed, Guernsey is well placed to accommodate ILS listings. Guernsey provides access to the London Stock Exchange (LSE) and other international exchanges, including Hong Kong, Toronto, Ireland, Euronext, as well as the Channel Islands Securities Exchange.
Appleby Guernsey is also currently advising on an ILS Cat bond structure whereby a pool of investors will invest into an incorporated cell of a Guernsey incorporated cell company, which will either be licensed under Guernsey's insurance law to reinsure catastrophe risks of the sponsor reinsurer, or, as an alternative to a reinsurance contract, will enter into a derivative contract with the sponsor reinsurer.
An original version of this article first appeared in the Guernsey Press.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.