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2/12 M97/February 2018 Reinsurance

In addition to the ‘prior’ cover already described, other types of ILWs include:
• live ILWs, which can be traded while an event is occurring;
• dead ILWs, which can be purchased if an event has already happened but the final loss amount is
2 unknown; and
Chapter • back-up covers, which protect against follow-on events such as flooding in the aftermath of a severe
storm.

C1D Reinsurance sidecars

Sidecars also These are limited purpose companies created to work in tandem with the reinsurance coverage provided
covered in
chapter 1, to an insurer. Sidecars are capitalised with debt and equity financing from capital markets and are liable
section D7 for only a portion of risk underwritten. Investors’ funds are used to underwrite all or a portion of an
existing policy. Sidecars allow insurers to write more business while limiting their liabilities. Sidecars
relate to defined and limited risks, are privately financed, and dissolve after a set period of time.

C1E Catastrophe futures
The value of a catastrophe futures contract is determined by an insurance index that tracks the amount
of claims paid out during a given year or time period. When catastrophe losses are higher than a
predetermined amount, the futures contract increases in value and the insurer makes a gain. Conversely,
if losses are lower, the contract falls in value and the insurer makes a loss. As the value of the contract
increases, the insurer can realise a gain in the short term on encashment which can be used to offset
any losses it has incurred.

C1F Insurance derivatives

A derivative is a ‘forward’ contract which enables a party to buy or sell a specified asset at a specified
time in the future at a pre-agreed price. This brings certainty that future trading will be fixed at
pre-agreed rates or within determined margins.
The insurance derivative is a development of this concept. Its worth depends on the valuation of
financial instruments, events or conditions. They allow insurers to transfer insurance risks to capital Reference copy for CII Face to Face Training
markets without having to provide prior liquidity against the maximum liability which could exist in the
event of a catastrophe. Their value is derived from a market loss index, which uses statistics to reflect
the losses incurred by the insurance industry, for example, as a result of severe weather.
The attractiveness of insurance derivatives is that they shift risk more efficiently than institutional
methods, avoid contractual costs of traditional insurance and reinsurance methods, and create liquid
markets for trading. Derivatives allow insurers to purchase protection from new pools of investors.

C1G Multi-trigger policies
Multi-trigger policies operate so that a claim is incurred only if one or more downside incidents occur or
flow from an original event all within a pre-defined range of dates. For example, business interruption
coverage may be included which acts as a secondary trigger if an insured event occurs and the insured
revenue falls by a predetermined percentage.
Clearly, there are pricing advantages, as a claim only results if there are sufficient events of loss or
damage to meet all of the policy’s criteria and trigger points. All losses below the predetermined
financial threshold would not be recoverable. This type of arrangement is suitable where an insurer has
determined its risk appetite and, having decided which events carry the largest negative effects, seeks
protection to meet those resultant cumulative losses.

C1H Catastrophe Risk Exchange (CATEX)
The Catastrophe Risk Exchange (CATEX) is an electronic system where insurers can trade insurance risk
and reduce their exposure to huge losses caused by catastrophes. Licensed risk bearers exchange or
‘swap’ catastrophe exposures offered by subscribers, allowing insurers and reinsurers to adjust their
underwriting portfolios in response to actual events as they occur. Insurers and reinsurers may
exchange, for example, a Japanese earthquake risk for a Caribbean hurricane risk. Parties would benefit
by reducing their exposure to the swapped risk which would then free risk capital for other
opportunities.