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The ILS Funds. Investing in Insurance Linked Securities – An Opportunity for Buy Side Innovation November 2008. Executive Summary.
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Investing in Insurance Linked Securities – An Opportunity for Buy Side Innovation
In 2008, origination has slowed only slightly. New uses for ILS (e.g., facilitating transactions) are adding to the new origination volume. Soft reinsurance pricing has not stopped ILS growh.
A basket of BB-rated ILS (SRCATTRR:IND) returned 44.0% from 11/7/2003 through 11/7/2008. This period includes the only insurance loss yet to occur – a recovery after the Katrina – Rita – Wilma storms of 2005. A well-regarded managed portfolio of corporate BB bonds (BHYAX:US) had negative returns over the same period. The most recent returns have sustained this view …
In the six months ending 11/7/08, two market changes have affected ILS prices. First, a repudiation of risk generally (flight to Treasuries) and of modeled risk in particular. Second, collateral quality is now a major issue in market pricing and four ILS issues traded sharply lower due to the use of corporate paper. ILS have still performed much better than similarly rated corporate bonds.
Spread over LIBOR (bps)
Est. Loss Cost (bps)
At 9-30-08 87 issues paid spreads above LIBOR >5x the expected loss costs ……
The current bid pricing can be used to calculate an expected loss ratio – the portion of the spread over LIBOR that will ultimately be returned as indemnification for losses. The average ILS is priced to an expected loss ratio as follows:
Priced and traded as a bond, an ILS is also a limited duration, specified and remote risk reinsurance policy. Thinking of it as reinsurance, this is hard market pricing, and exactly the pricing environment where successful companies get created.
Assembling a portfolio of cat bonds can be done without broker commissions, the high overhead of a Bermuda office, or the risk of adverse development in old accident years. Compared to operating an insurance company, both loss costs and expenses are lower :
Lower operating costs lead to higher profits with less risk….
ILS pay a much higher return per quanta of risk. The profitability of the spread over LIBOR is analogous to reinsurance premium, and can be used in measures of underwriting profitability:
ILS investing is low leverage – $1 invested is $1 at risk. Reinsurers take on over $2 of risk for every $1 of capital. Debt and “side cars” both increase leverage and present risk returns as service fee income. The ILS Funds will be deploying capital over the course of 2009, and will be only 30% deployed on average. Even after this leverage, higher returns come from a portfolio of ILS holdings:
A $1 of risk pays ILS investors $6.32 while reinsurers get $1.11.
A real world example follows: one company’s insured exposures and the 1938 hurricane.
must master and model the detailed data
Experienced insurance operators, we insist on closing with the data. This produces better ILS investment decisions.
ILS are complex securities, but simpler than MBS.
Portfolio results are largely driven by non-correlated risks.
Sources of New Business
Assuming future growth at half the historical rate, the new originations increase from the current $14b to $119b per year.
Total volume outstanding is projected to grow to over $300b, again assuming growth at half the historical rate.
The ILS Funds
opportunities per year
NB, Partner, FSA
Responsible for management of the life fund, NB is a senior actuarial partner with a Big 4 accounting firm. His background includes 20 years of actuarial consulting and 5 years of operating life, credit life and annuity insurance companies. He has been involved in structuring and purchasing reinsurance for the bulk of his career, and is currently responsible for the life securitizations of the nation’s largest insurer. He will devote full time to The ILS Funds.
Preston Kavanagh, Partner, CPA
Responsible for overall management of the funds, Preston is an experienced insurance entrepreneur who also has 10 years of experience in the operation and management of investment funds targeting the insurance industry. His background includes 10 years with KPMG (8 years in actuarial consulting), 10 years as a partner managing the Conning Capital Funds, and 5 years operating property-casualty insurance companies. He has been involved in structuring and purchasing reinsurance in workers compensation, homeowners insurance, commercial specialty lines and excess and surplus lines, including membership on the Reinsurance Security Committee of Alleghany Corporation. He contributed to the development of the risk based capital models used by the NAIC and AM Best, and is familiar with the risk capitalization models used by the major rating agencies. CPA, CMA, CLU, ChFC. He will devote full time to The ILS Funds.
MA, Partner, FCAS
Responsible for management of the non-life fund, MA is the risk and reinsurance officer of a property insurance company with 400,000 insured locations. He has been involved with insurance and reinsurance of property risks for the bulk of his 25 year career, including 2 years spent developing one of the leading cat models and 5 years steering the development of the other model as that company’s beta user. He will devote full time to The ILS Funds.
[Support for cat bond modeling, out of cat modeling firm].
[Support for mortality / morbidity modeling, out of actuarial consulting firm].
[Utility infielder for investment cash flow analysis and modeling, out of NY group focused on ILS].
[Support for IT and communications technology].
Responsible for the day to day cash operations and reporting of The ILS Funds, AS has 8 years of experience as the controller of the Conning Capital Funds. This involved accounting and reporting for 20 entities and 120 limited partner interests.
Investing in ILS requires expertise in insurance company data and operations, catastrophe models, and acting on the relevant insights. Only The ILS Funds brings the expertise without conflicts. The best choice for your ILS manager is The ILS Funds.
Actuarial Consulting, Non-Life
Actuarial Consulting, Life
Innovative Computer Systems
The ILS Funds are now seeking expressions of interest. If you would like to receive additional information, please contact [fund raising agent], at the following:
To schedule a meeting with the fund managers, please contact the following: