Abstract
“If there were no losses; there would be no premiums,” Insurance proverb. This paper analyzes the history of natural catastrophe Insurance-Linked Securities (ILS), or Cat Bonds (CB), from 2001 to 2020. Preliminary analyses summarize the annual character of issuance during that period, providing context for the principal focus of the paper, which is losses. A detailed loss record is provided, including why and when losses occurred. This record, when set against the historic issuance, allows us to address several important questions, unaddressed in the literature but constantly posed by practitioners. Does the cumulative loss over 20 years equal what catastrophe models led to us expect? Were the relative sizes of actual losses reflective of expected losses? Most importantly, does the loss record support the idea that natural catastrophe models are accurate and useful? This paper is the first to specifically address these fundamental forensic questions against the loss record. It thereby makes an important contribution to the growing literature about ILS markets.
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Notes
Collateralized-re transactions, Industry Loss Warrantees [ILW]s, and Sidecars constitute the bulk of the other Alternative market instruments. They are not part of this study.
The terms Cat Bond and Nat Cat ILS are used interchangeably herein. The latter being the more modern practice.
Certain Mortgage, Auto securities, and Longevity swaps which embed insurance and/or residual value risk are sometimes considered part of the wider ILS market. They are not documented in this study.
It is implicitly assumed that the portfolio of ILS of different risks and perils stays fairly constant from year to year.
To be clear, the EL we are analyzing is the annual EL listed in the Offering Circular. Since different companies conduct the risk analysis for different securities, we are agnostic about the modeler. Since each modeler may remodel each other’s efforts a “remodeled EL” is often available to investors. That is not considered here. Similarly, “reset” requirements will often mean that a “reset EL” may be available to investors, post original issue date. Those too are not the ELs recorded herein.
A better acronym might be IBNFR—incurred but not fully reported, but instead we utilize the more familiar IBNR.
Secondary market price indications are usually on original issue limit. A convention is developing that when a partial loss payment has been made, price is subsequently quoted on the remaining limit. This creates problems for observers or analysts. The partial payment is not always public, different dealers adopt the remaining-limit practice at different times and some may not record the amount of the remaining-limit basis for their quote. This is a confusion that could be cured by standardization of practices and/or greater transparency.
The market estimate used herein is the midpoint between bid and ask quoted prices and further averaged over all available pricing sheets.
Astute readers will note that the average time on-risk is less than average term (2.04 years vs 3.3 years). This is because many of the recent issues will still be on-risk beyond the study horizon in this analysis (12/31/2020).
This measure, the PFL, can be a useful annual indicator of frequency. When multiplied by the number of deals outstanding in any year, it will give the number of ILS expected to be loss-affected that year.
Larger catastrophic losses existed in 2001 due to the terrorist attack on the World Trade Center. That loss was large but was “man-made,” not a natural catastrophe—the focus of this paper’s analysis.
Even if we randomly chose the eight years the ILS market experienced a loss, a simulation of results will display a distribution whose mean is close to $3,758 million.
The number 5.15% annually is an arithmetic average. Most independent industry return indices (Aon, Swiss Re and Lane Financial) are given in “compounded” equivalents, and over the twenty years in question hover around 6%. These two numbers are not inconsistent.
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General References
AIR Worldwide. 2020. (Multiple papers). http://www.air-worldwide.com/insights/articles.
AON Benfield. Insurance-Linked Securities—Research Reports (multiple years).
Swiss Re Institute. Insurance-Linked Securities and Sigma Reports (multiple years).
Acknowledgements
The materials gathered herein benefit from the information consistently provided from Aon Securities, Guy Carpenter and at times from Goldman Sachs, Swiss Re Capital Markets, and other colleagues and providers. Model analysis benefits from materials provided courtesy of AIR Worldwide.
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Lane, M. The ILS loss experience: natural catastrophe issues 2001–2020. Geneva Pap Risk Insur Issues Pract 49, 97–137 (2024). https://doi.org/10.1057/s41288-022-00275-5
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DOI: https://doi.org/10.1057/s41288-022-00275-5