Recommendations announced to spur further growth of the market

A new report published by the World Economic Forum provides recommendations to help spur continued growth of the market for insurance-linked securities (ILS).

Produced in collaboration with partners in the global financial services industry, Convergence of Insurance and Capital Markets explores the growth of the ILS market and highlights potential next steps needed to continue the development of ILS and to further encourage investors’ strong appetite for catastrophe (“cat”) bonds and other forms of insurance-linked products.

Having grown between 40% and 50% annually since 1997, the ILS market for securitised general insurance liabilities has held up well in the current difficult environment. However, there are a number of issues that could potentially restrain growth, the report says. Among the key themes addressed in the report are investors’ appreciation for transparency and the need for continued improvements in data regarding the risks to which they are exposed through ILS products.

ILS – strong growth for more than a decade

The ILS market has seen strong growth since its inception in the mid 1990s. The notional value of outstanding ILS increased from US$ 26bn in 2006 to US$ 39bn at the end of 2007, and there are experts who are predicting robust growth over the next several years.

Speaking at the report’s launch in London this morning, Dieter Wemmer, Chief Financial Officer of Zurich Financial Services – the project chair and one of the companies co-sponsoring the report – commented: “Driven by a need to finance growth, manage capital and transfer risks related to extreme events such as hurricanes, earthquakes and pandemics, (re)insurers are increasingly turning to capital market solutions. Investors find insurance-linked products attractive because they typically provide robust yields and represent an opportunity for risk diversification – particularly important in the current financial climate.”

Widening the investor base – standardisation and data transparency are key

Fostering a broader and stronger investor base for cat bonds means, for example, that the market must take steps to attract wider direct interest from institutional investors to supplement their indirect investments via the specialist firms which represent the bulk of investor interest to date. According to the report, achieving this requires a broad focus on educating previously untapped investor groups. While customised structures will continue to have their place, cat bond transactions and the documentation of insurance products must become more standardised, in terms of contracts, deal type and data provided.

Swiss Re is another co-sponsor of the report. According to Dan Ozizmir, Swiss Re’s Head of Insurance-Linked Capital Markets, the issue of data transparency is key to securing a broader investor base. “The industry discussions held during the creation of this report were extremely positive about the market’s growth up to now, but pointed to a number of issues which need to be addressed to ensure that its development can continue at an even greater velocity. In particular, the report urges ILS issuers to improve data transparency by issuing more data on the risks being transferred,” he said at today’s launch. “This will build even greater trust and communication between cedents and investors, leading to growth and greater market efficiency.”

Addressing the challenges – significant progress is underway

Various initiatives to accelerate the growth of insurance-linked risk transfer are already underway:

• The International Swaps and Derivatives Association (ISDA) has formed two working groups to improve the standardisation of derivatives related to insurance risks such as natural catastrophes, longevity and mortality

• Separately, a group of insurers and reinsurers is setting up an entity to collect and provide data on European natural catastrophe losses, with a view to using the data as a basis for risk-transfer transactions

• Swiss Re has created a total returns catastrophe bond index to provide a benchmark for investors in ILS catastrophe bonds

• Exchanges such as the Chicago Mercantile Exchange and the Insurance Futures Exchange Services have recently begun to trade insurance-based derivatives

• Further, insurance regulatory capital frameworks such as Solvency II are expected to bring more consistency to the types of securitisations used by financial institutions

Giancarlo Bruno, Director of Financial Services at the World Economic Forum, said: “Today’s report points to future opportunities for all stakeholders in the ILS market. The report shows that there are some fundamental issues to be addressed if these opportunities are to be seized to their fullest potential, and that these will not be simple, fast or easy to overcome. In order to maintain the growth of the insurance risk market, concerted action will be required from market participants over many years ahead. Those players who have so far driven its growth are already engaged in taking steps to address areas such as data availability and quality, and this momentum needs to continue.”

Paul Achleitner, Member of the Board of Management, Allianz, Germany, pointed out: "In certain risk areas we see an increasing need for capacity, for example weather-related insurance claims have increased 15-fold over the past 30 years. In this challenging situation, ILS provides new, fully collateralised and multi-year capacity for the risk-carrying industry, along with a high degree of risk diversification, which makes them attractive for investors as well."

“We appreciated the opportunity to work with the World Economic Forum and its partners on the convergence of insurance with the capital markets. Although this topic has been top of mind for some years, with the

current turmoil in the markets, this initiative demonstrated the collaborative efforts of the Partners in creating more visibility into the potential for future growth of this market,” said Jack Ribeiro, Managing Partner Global Financial Services Industry, Deloitte.

Convergence of Insurance and Capital Markets is published by the World Economic Forum in cooperation with Allianz, Barclays Capital, Deloitte, Thomson Reuters, State Farm, Swiss Re and Zurich Financial Services (project chair). The report represents the culmination of a year-long research project including more than 60 interviews with business leaders, regulators, rating agencies and leading academics.