Insurance-Linked Securities Report 2008 - Aon

Insurance-Linked Securities 2008
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While sponsor demand for the structure has always been strong, investors previously
tempered the use of indemnity through higher risk premiums. However, investors have
gained valuable experience in this market and many have expanded their modeling
and analytic capabilities, increasing their acceptance of indemnity triggers. Many
investors have developed internal modeling teams and currently license one or more
catastrophe models. Additionally, modeling firms have released specific catastrophe
trading models that investors are beginning to implement. Finally, many investors
are evaluating new transactions using a multi-model approach, similar to traditional
reinsurance markets.
This increased acceptance, combined with the emergence of sophisticated sponsors
willing to make significant disclosures regarding their claims payment practices,
has improved the pricing and capacity gap between indemnity and non-indemnity
transactions and sparked significant growth in indemnity securitizations.
It is also important to note that investors showed a preference for transactions which
featured quality underwriting, independent third-party modeling, and straightforward
structures. Some recent transactions tested the market’s acceptance of different
modeling approaches. One transaction, which relied on a proprietary internal model,
was cancelled due to a lack of investor interest.
Pros And Cons Of Indemnity Triggers
Similar to other forms of securitization and reinsurance, indemnity triggers have
a number of advantages and disadvantages. A complete understanding is vital to
determining if it is the proper trigger for each sponsor.
The primary benefit of an indemnity trigger is simple: payments are based on a
sponsor’s actual losses, consequently reducing basis risk for the sponsor as compared
to a non-indemnity structure (such as parametric or index structures). Additionally,
as a risk transfer solution, indemnity cat bonds receive reinsurance accounting
treatment with losses and recoveries accounted for as part of underwriting results.
That said, indemnity triggers do have some drawbacks compared to non-indemnity
triggers:
• Higher risk premium. Due to additional uncertainties such as the ongoing
management and underwriting policies of the sponsor, investors typically
require a higher risk premium from indemnity bonds.
• Complexity. Indemnity transactions are typically more complex to
structure, which results in higher fractional costs, greater demand on
sponsor resources, and an increased time to market.
• More disclosure. Indemnity triggers also require increased sponsor
disclosure, including current and historical policy and exposure
information, underwriting and claims practices, risk management
strategies, and relevant loss history.