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Risk linked securities
- enable ins risk to be transferred to capital mkt
- provides ins w additional capacity
- cat that are large for insr are small for mkt
- incl cat bonds, sidecards, cat-e-puts, cat risks swap, ILW
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CAT Bonds
- most common type of risk linked security
- insr creates SPReinsr to shield investors from bus risk
- fixed inv return swapped for floating to immunize against int rate risk
- bds have call option triggered by CAT (1) indemnity trigger based on insr actual loss, (2) index trigger = ind loss, modeled loss, parametric index (physical measure) (3) hybrid
- investors prefer industry loss index trigger, insr indemnity
- covers high layer that involve reinsr cr risk and high reins profit margin.
- Sold in multiyear format
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Sidecars
- SPV formed by (re)insr to provide add'l capacity
- (+) usually off balance sheet
- (+) can be formed quicly at low documentation cost
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Cat-e-puts
- put option giving insr right to issue preferred stock when cat
- (+) raise funds quicly
- (+) lower trans cost than cat bonds (no SPR)
- (-) not collateralized -> cr risk
- (-) value of existing share diluted by pref stock
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CAT risk swaps
- (+) reduce core risk & achieve diversification
- (+) low trans cost
- (-) difficult to achieve parity
- (-) can create more exp to basis risk
- (-) not prefunded
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Industry Loss Warranties (ILW)
- (+) considered as reins by regulators
- (+) dual trigger: retention (insr loss) & warranty (ind loss)
- 2 categories of pmt: binary trigger (both), pro rata trigger (based on magnitude by which loss > warranty)
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Factors allegedly impeding growth of CAT bds mkt
- regulatory: cat bds issued offshore (low trans cost, well performing jurisdictions)
- accounting: uncertain treatment due to basis risk (narrow geog area, dual trigger)
- tax issues: no particular tx impacting cat bds
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