Industry Loss Warranties (ILWs) are a well-established risk sharing tool used widely by risk carriers, including captives and Insurance Linked Securities (ILS) funds, to secure uncomplicated protection against many conventional natural perils. However, they are not always easily understood. Miller's Ken Evans sheds some light on this type of cover.

What is ILW cover and how is it triggered?

ILW is just another form of reinsurance. It is a simple policy that allows a cedant to protect their book of business without having to produce any information which may of course be sensitive.

An ILW can be both an insurance and/or a derivative contract. Some funds historically have bought to protect their entire portfolios some of which may not be related to insurance. Whereas the insurance industry will buy on an indemnity basis and the contract will have an Ultimate Net Loss (UNL) clause as proof of loss albeit with a very small retention. 

As the name implies, ILW payments are triggered when the entire insurance sector’s aggregate losses exceed a specified threshold. The threshold amount is pre-determined and specified in the contract.   The amount is as determined by an agreed index (usually perils for European risks and Property Catastrophe Service [PCS] for North American ILWs). When triggered, a specified payment of the full contract limit is made to the warranty holder. 

There are different types of contract trigger:

  1. Occurrence ILW- in this case the index will be used to show the amount for a single event industry loss
  2. Aggregate ILW – in this case the index will be used to consolidate a set number of industry loss events

Claims loss development 

As recent natural catastrophes have demonstrated an accurate picture of total industry losses can take a long time to develop. Recognising this the period during which the ILW buyer can make a claim is also quite long - up to two years for wind and three years for earthquake. 

Contracts themselves are typically annual, and may be sold before, after, or even during an event (making the latter a form of ‘live cat’ cover).

Pricing and trigger design

The indices used may or may not provide a precise measure of industry losses from, say, a cluster of storms, but that doesn’t really matter. The likelihood of loss can be modelled by anyone with access to the appropriate tools, which is one reason alternative capital providers have been avid suppliers of ILW capital: they are able to calculate the expected loss rate with reasonable comfort.

As a result of this trigger design, ILWs do not provide an indemnity that reimburses specific losses incurred by the holding insurer. A benefit to the buyer being they do not have to provide any information of their account, keeping their aggregates confidential. 

Additionally the amount due is known in advance, with settlement therefore much faster. 

Reinsurance variance- clear evidence of insurable interest

However, when the ILW is booked as a reinsurance contract, ILW buyers must have an insurable interest in the event. This type of instrument may be called an indemnity ILW, and requires the reinsured to suffer a specified level of retained loss from the insured event. 

Without this, ILWs must be booked as a financial derivative. The nature of the contract may be determined by the seller. If a reinsurer, it is more likely to be a contract of reinsurance, but many alternate investors in insurance risk, typically hedge funds, also sell ILW contracts.

Pricing trends

Following two years of intense natural catastrophe activity that has cost the insurance sector in the region of USD200bn, ILWs have been tested. Some capacity has been withdrawn or has been trapped (this is where buffer zones built into the contract have been breached allowing the capital to not be released even though it is unlikely the policy trigger will be breached), and the cost of this form of protection has been rising in the face of heightened demand. 

Pricing has increased in 2019 due to the losses mentioned in 2017 and 2018. For business that has been loss affected, increases of 15% and above have been seen, however ILWs which are clean (no loss) have been 5% to 10% up.

Current estimated market size

Again, the market size has decreased in 2019 due to the significant losses in 2017 and 2018; it is however difficult to estimate the actual market capacity available due to the fact placements are always 100% between buyer, seller and intermediary. As such, no one party ever sees the overall position. Historically, capacity available has been estimated at around USD4bn but the accuracy of this figure remains questionable.

Trends in the popularity of types of ILW

As mentioned earlier, there are really two types of ILW: traded occurrence covers and aggregate covers. Occurrence is still widely available, however aggregate is a sought after commodity and trades at a premium. 

Also, with regards to perils, where it was de rigeur to include all natural perils covers, far more business for 2019 is placed on a more restricted named windstorm and earthquake basis only. Wildfire at the lower levels of attachment is now normally excluded, with markets not wishing to expose their balance sheet/investors to further losses from this peril. 

Get in touch with our specialist team

Miller now has market-leading expertise in this specialist field. At the end of last year, Miller acquired Alston Gayler & Co., an independent London market re/insurance broker specialising in multiple lines of business, including ILWs. To learn more about this flexible and relatively uncomplicated risk transfer instrument, please get in touch with Ken Evans.

Contact Ken