Lack of reinstatements on ILS coverage to drive some ILW demand

The fact that insurance-linked securities (ILS) such as catastrophe bonds and collateralized reinsurance arrangements generally do not feature reinstatement provisions, means interest in industry loss warrants (ILW’s) could remain higher through the end of this year.

We’ve already reported ILW activity in advance of the recent hurricanes as live cat trading, as well as after they struck as dead cat trades as well.

But interest in industry loss warranty (ILW) backed reinsurance and retro protection may increase following these events and rating agency Fitch believes insurers and reinsurers could look to replace eroded coverage, or secure a hedge for the rest of the U.S. hurricane season, using ILW’s.

Both hurricanes Harvey and Irma saw some ILW’s trade as they approached and also after landfall. The first two major hurricanes to strike the United States in over a decade have reminded the market of the benefits of reinsurance and retrocession, and the role that an ILW can play in providing additional or replacement coverage during times of perceived market stress.

Recent losses have also reminded all market participants that there is a place for hedges that can be quickly and easily instated, as losses threaten, or after events to replace eroded protection layers.

Fitch said that as insurers and reinsurers impacted by the recent hurricanes may be seeking continuity of coverage following the storms, if they have leveraged collateralized reinsurance or catastrophe bonds they may not have any reinstatement provisions available to them.

Of course this also goes for traditional reinsurance as well, as a lot of it lacks reinstatement provisions too.

Hence companies could find their reinsurance or retrocessional protection lacking across the remaining months of the hurricane season and through Q4, leaving their balance-sheets more exposed to potential losses if they do not top-up their coverage.

“Cedants seeking to maintain catastrophe coverage at the same levels have options to buy other short-term specific coverage, including ILWs,” Fitch Ratings explained.

In some cases, buying protection to cover the remaining few months of the year may be preferable to reinstating a full program anyway, as an ILW or other short-term reinsurance arrangement could be deemed more flexible and allow a cedent to develop a strategy for replenishing its program more fully at the next major reinsurance renewal season in January.

But for some re/insurers, the need to demonstrate they are protected is most important. Hence there are companies looking for back-up coverage which have not eroded their full reinsurance program limits, but who have become more nervous in the wake of the major storms.

It’s not always a cheap option though and Fitch says that ILW’s purchased as back-up protection are likely to “Grow more expensive in periods of unique higher demand.”

ILW’s remain a useful tool in the reinsurance and retrocession box and following such major storms it will be interesting to see how their uptake changes, if at all. They can be particularly useful for those lacking reinstatement provisions and those looking for short-term hedges.

As we wrote before, ILW payouts could be in the billions following recent loss events and retro market participants are expecting large payouts to be made. Just how much ILW capacity is eroded following recent storms remains to be seen, but it is likely that once the market is fully bought again the size of the ILW market could be even larger.