An update on the use of modern financial instruments in the insurance sector

Abstract

The world's financial markets have exploded with new products and new techniques such as derivatives and securitizations, giving rise to huge new markets. The author reviews recent developments in insurance-linked securities (ILS), financial products that link insurance and reinsurance with these new markets. Pricing and availability problems after Hurricane Katrina have led to newer types of products making their way into these markets. While catastrophe bonds still make up a significant portion of ILS, the risk of not recovering reinsurance receivables, for instance, can now be transferred to the financial markets via credit derivatives. Catastrophe risk can also be packaged as a credit derivative. New participants, like hedge funds and specialized mutual funds, have also caused a revival of exchange-traded ILS. Trading in catastrophe futures and weather derivatives is thriving. Sidecars were revived. Contingent capital is readily available. New perils, combined with others, are being covered. Insurance and reinsurance companies can no longer treat these instruments as a matter of relative pricing between traditional products and ILS. After Katrina, access to multiple sources of capital has become an essential strategic objective. © 2007 The International Association for the Study of Insurence Economics.