ILW’s can pave way as repeatable structures to fuel ILS growth: PCS

The use of an industry loss warranty (ILW) structure in inherently complex and rapidly advancing risks, such as cyber and terror, could support the repeatability of other structures and ultimately assist the innovative efforts of the insurance-linked securities (ILS) market, according to Property Claim Services (PCS), a Verisk Analytics business.

In phase two of its ‘Reinsurance Manifesto,’ PCS follows up on the need for industry collaboration to expand the remit of the ILS market, with a call for the development of repeatable structures.

The reinsurance and ILS market has been innovative over the years, developing bespoke structures and solutions to meet demands.

However, PCS explains that historically, the risk transfer industry has seen innovation as an individual achievement, and calls for a collective and needs-based approach to innovation in order to develop lasting solutions that really make a difference to the marketplace.

“For the ILS sector to grow dramatically (even in comparison to 2017), we need to find solutions that stick. Showing that you can “get a deal done” is important, but it doesn’t fuel sustainable growth. ILS – and even insurance – market expansion requires the industry to rise up and overcome the temptation of innovation without repeatable utility,” says PCS.

The report states that sustainable innovation can be achieved if the industry works together to develop solutions that meet the needs of the market, highlighting that if a product satisfies a real need in the marketplace it will be used over and over again.

PCS explains that cyber and terror are both exposures where the industry has focused on the individual rather than the collective.

“Both terror and cyber have received significant efforts at innovation, and the need for risk-transfer tools in both classes of business is palpable. An occasional clever solution provides immediate relief for one client and a glimmer of hope for the rest of the market, but excessive tailoring ultimately becomes a barrier to repeatability.

“While both risks may be somewhat exotic, the market clearly craves a risk-transfer solution that is not,” says PCS.

When it comes to cyber and terror, two risks that are constantly evolving and which provide a real opportunity to the ILS and broader risk transfer industry, PCS feels that an ILW structure, with a similar industry loss index trigger that has supported the U.S. property cat space, could offer the “good for the greatest number.”

This notion was discussed recently by PCS Assistant Vice President (AVP), Tom Johansmeyer, speaking with A.M. BestTV at the 2018 Artemis ILS NYC conference held in early February in Manhattan, who said that ILW’s could ease the entry of ILS capacity into cyber risk.

While an ILW market has yet to emerge in the cyber space (although we understand interest is developing), and PCS’ report highlights that the need for retrocessional capacity is expanding rapidly, with some believing that acute capacity needs aren’t too far away.

“To fuel future market growth, some sort of commoditization of cyber reinsurance risk must occur. Otherwise, the process will become too cumbersome and expensive, ultimately constraining future expansion. Repeatable risk transfer is an important part of the future of the cyber insurance market,” says PCS.

Regarding terror, PCS notes that it’s typically traded fairly actively and there’s “plenty of demand in the ILW market.” However, trading has slowed in recent years as a result of ambiguous triggers that make it challenging for people to participate, with the process not being either reliable or repeatable, resulting in pent-up demand.

Furthermore, both cyber and terror have crept into natural catastrophe programmes during the soft market environment, which could result in unexpected and large loss accumulations.

“An ILW solution would help, particularly as reinsurers have assumed terror without additional rate, instead using it to maintain original pricing on the property­catastrophe business. With an ILW, it may be easier to manage the cost of risk transfer,” explains PCS.

The report concludes that both repeatability and simplicity are “crucial to new solution adoption,” and stresses that if a solution meets a clear need then repeatability and adoption will come naturally.

“Original risk can be difficult to transfer throughout the insurance and reinsurance value chain. Tools that make it easier to free up capacity, of course, can help a fledgling market endure its early days and then mature more easily in the future. In particular, industry loss index triggers can be crucial to the risk­ transfer process as a market develops,” says PCS.

Ultimately, PCS feels that the repeatability of ILWs in a market, such as cyber, can assist with the repeatability of other structures in the future, providing clients and the market with much-needed solutions while expanding the scope of the ILS market.