During the past twelve months, capital has continued to flow into the reinsurance markets in the form of both insurance-linked securities (ILS) and collateralized reinsurance transactions. This report examines the growth in the ILS market during the past year and some of the important evolutionary elements of catastrophe bond structure and risk transfer. We also explore how the use of capital markets-based capacity provides cost savings for public entities by helping them build surplus, reduce public debt and limit the risk that natural perils can pose to the state’s balance sheet. As collateralized markets continue to increase in importance as an alternative to both traditional reinsurance and ILS, Guy Carpenter has taken an active role in analyzing counterparty risk and developing specific structures and strategies to manage this risk. This report also provides an overview of the manner in which Guy Carpenter assists its clients in managing counterparty risk and limiting credit exposure.
One common theme in the development of both ILS and collateralized markets is the change in the location of where the capital to back insurance claims is held. In the case of traditional reinsurance, using a rated carrier, premiums are paid by a cedent to a reinsurance company, then the reinsurer will pay any claims out of its capital base after the insured or the cedent has made a claim. In the case of ILS structures, the insured or the cedent holds the proceeds of the security until either the equivalent of claim has occurred or the proceeds are returned to the investor when the security matures. Simplistically, in the case of reinsurance using a rated carrier, the reinsurer holds the money - in the case of ILS and collateralized markets, the insured holds the money or it is held in trust for the insured.
This major structural difference between rated and collateralized markets has given rise to well-defined structures and verifiable parameters as alternatives to the traditional claims process. The continued development of these structures and parameters will provide for further risk transfer to the collateralized markets. Also, as the ILS and collateralized markets continue to innovate in these areas, rated reinsurance markets will utilize some of these same triggers and techniques, creating another form of convergence between the rated and collateralized markets.
As discussed further in this report, one major innovation that occurred in the past year is the transfer of risk directly from the risk-bearing entity to the capital markets, without an intervening insurance company. With the issuance of its MetroCat Re Ltd. (MetroCat) bond, the Metropolitan Transportation Authority (MTA ) transferred the risk associated with storm surges and flooding directly to capital markets investors without an insurance company acting as an intermediary. As the quality of catastrophe modeling continues to increase and as capital markets investors become more comfortable with innovative terms and conditions, more forms of risk may directly access the capital markets in ILS form.
In the case of collateralized markets, the theme of where the capital to pay claims is held has created a new form of risk analysis. Rather than focusing on traditional credit analysis, cedents rely on trust structures and agreements and the quantity and quality of available collateral as security against claims. This report looks to these elements in the development of collateralized market security and the role that Guy Carpenter plays in assisting its clients in the formation of effective collateralized reinsurance structures.
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