What is an ILS?

An ILS is a financial instrument whose value is based on an underlying book of insurance business. For this reason, ILS are often considered to be derivative financial instruments. The value of the ILS comoves with the value of the insurance business.

Many financial instruments are traded in liquid markets with many buyers and sellers. In many cases, such as publicly-traded equities, the same reliable and relevant information is available to inform buyers and sellers, which is reassuring for both parties. For an ILS, the information available to investors may be less reliable, relevant, or understandable than to issuers, leading to an asymmetry that often favors sellers. The insurance market has many practices and terms that financial market participants may find unfamiliar and unclear.

Issuers of ILS include insurers or reinsurers. In general, the issuer sells the ILS to investors in the financial markets, possibly with the help of an intermediary, thereby transferring insurance risk to financial market investors. Previously issued ILS can be traded in secondary financial markets such as on some stock exchanges, or in private transactions. By originally selling the ILS to financial market investors the issuer gains access to additional sources of capital beyond the insurance markets, which was historically the main source of issuer capital.

There are many types of ILS currently. In the mid-1990’s catastrophe bonds (“cat bonds”) were first issued based on an underlying book of property insurance. The cat bond investor expects to receive periodic interest and a return of principal at maturity, unless a natural catastrophe like a hurricane occurs in which case the investor’s return could be diminished. If the catastrophe is severe enough the investor could lose principal as well as interest. There are many variations of cat bonds.

More recently, ILS have been issued on underlying casualty books of business. These can be of many types but a quota share structure is common in which the investor and issuer both share proportionately in the profit (or loss) on the underlying book of insurance.

What is the value of an ILS?

Insurers or reinsurers interested in issuing an ILS often seek diversification of their capital sources by expanding beyond the insurance markets. The financial markets are much larger than the insurance markets. They may also seek more favorable pricing than what is available from the insurance markets, especially because reinsurance pricing tends to be cyclical in nature.

Investors typically seek to diversify their portfolio by adding insurance risk. Some investors consider ILS to be “zero-beta” assets, meaning the expected return on the ILS does not comove with expected returns on traditional financial instruments such as equities or bonds. Adding a zero-beta asset to their portfolio reduces risk and may increase the expected return.

How can Huggins help?

An ILS bridges the insurance and financial markets. Issuers and investors both want transparency, reasonable estimates of ILS pricing, independent advice, and timely objective information to guide their decision-making.

The experts at Huggins have decades of experience spanning the insurance and financial markets. We have developed several valuation approaches that are tailored to the specific terms of the ILS at hand to yield a fair and reasonable point estimate price, or a reasonable range if desired. We are bound by strong standards of professional practice to provide objective advice. Our reports are written clearly and are understandable to financial and insurance market participants. We take the matter of independence seriously, and while we always welcome client feedback, our conclusions are unbiased.

We can estimate the price, or range as the case may be, for new issues before they are first taken to market, or for ILS traded in the secondary market. Clients can be ILS issuers, intermediaries, or investors. Several Huggins professionals provide litigation support, as needed.