ILW: five lessons for the summer
Two years of catastrophe activity around the world and the expansion of new lines of business have made the industry loss warranty (ILW) market an interesting, dynamic, and growing space. This has also shown up some of the challenges that have emerged as ILWs have been tested heavily and in a variety of ways.
The good news is that such activity results in plenty of opportunities to improve the ILW structure and the market as a whole. Soft markets help us learn the limits of creative structuring; hard markets help us learn the implications of it. Let’s take a look at five important lessons to focus on this summer:
1. Florida is an emerging market—of sorts
Florida may be one of the most thoroughly modelled parts of the world, but we’ve learned a lot over the past two years. After Hurricane Irma in 2017 struck as the first mega-catastrophe in more than a decade, our market saw the true value of direct experience.
Insurers that didn’t exist when the state was last tested put their catastrophe plans to work for the first time—a challenge exacerbated by a shortage of claims talent caused by unprecedented demand for such resources. There was also the impact of the regulatory environment (particularly assignment of benefits), which made risk bearers question what it really means for a claim to be closed.
2. Past events are not a template for loss development
Prior to 2017, only a handful of catastrophe events had development periods of more than 20 months. Of them, only one was a hurricane: Katrina. Today, we have three catastrophes open that may reach the 24-month post-event period referenced in ILW wordings: hurricanes Harvey, Irma, and Maria.
The first of this trio should be updated in early August, a few weeks in advance of the ILW extension deadline. The same for Irma and Maria should follow quickly after. As a result, what was once a theoretical constraint has become real, which should at least encourage a second look at how the ILW product functions within the context of longer-developing catastrophe events.
3. Trigger discipline is crucial
It’s no secret that, in some cases, ILWs are instruments of last resort. When a cedant needs a certain amount and type of protection, it’s not unusual to take on some trigger failure risk alongside basis risk.
Historically, this has been quite common for ILWs covering Japan, and also for worldwide aggregate covers. Three 2018 catastrophe events highlighted the challenges of using reporting agents that aren’t designed to be triggers, and the significant development shown by Jebi has been particularly problematic. Some ILWs did not trigger as expected, given the reporting agents used.
The entry of PCS into the Japanese market provides a remedy for the future, but the difficulties encountered by 2018 ILW covers should stimulate some discipline for ILWs not yet able to use PCS indices as triggers.
4. Understand the universe
For lines of business with experience in the ILW space, it’s pretty easy to understand the nature of the cover provided. Even in some specialty lines, this is the case—market participants have a pretty good idea of the universe covered by a $2 billion single-risk marine ILW.
For new classes of business looking to broaden their access to capacity and risk transfer tools, however, a more diligent approach may be required. For example, the Bermuda market has shown a considerable increase in cyber appetite over the past year, with a particular focus on ILW trading, although a quickly evolving market means that last year’s big tower could be pedestrian today.
Single-risk cyber ILW trading would therefore benefit from a more clearly delineated universe of potentially affected programmes to support pre-trade analysis and decision-making.
5. Expect the unexpected
When the Fort McMurray wildfire affected Canada in 2016, it became the largest insured loss of its kind recorded by PCS in North America. Now, it’s been pushed further down the list by the Californian Camp and Tubbs wildfires of the last two years.
It’s no longer unusual to see multibillion-dollar insured losses from events that include hail in the US; in Istanbul in the summer of 2017, PCS designated a pair of hail events with significant insured losses. More than 80 per cent of the insured loss from them was due to motor physical damage.