Insurance-linked securities (ILS) are a product of financial innovation development. They are a result of combining capital markets and the insurance industry, and this form of security model has been employed by insurers who are eager to tap into new sources of capital market funding.
ILS have been on a steady rise for several years now. As reported by the Swiss Re, ILS have broken the record — there was around $3.28 billion issued only in the first quarter of 2018.
In the second quarter, ILS issuers issued approximately $4.03 billion, and while the first half of 2018 didn’t produce a new record compared to 2017’s $8.4 billion, Artemis reported that 2018 maintained higher than average values, mostly because the third quarter of 2018 had another $1.55 billion issued in bonds.
As you can see, there’s no denying that insurance-linked securities are growing in popularity and are being used more often. However, they are also expanding across different verticals, and one of the many reasons for that is in the way ILS work.
How Do Insurance-Linked Securities Work?
Understanding ILS is relatively easy. Simply put, they are a way for insurers, as well as reinsurers, to pass the unwanted risk to capital markets. Capital market investors, such as institutional investors, pension funds, and even other insurance companies provide collateral for ISL, and investors from the asset class take on the risk passed down from insurers and collect premiums or pay out losses if and when they materialise.
Naturally, why and when an insurer will pay out losses depends on the type of the ILS, and there are numerous ILS segments in the insurance market.
Where Are Insurance-Linked Securities Used?
One of the most common segments of the ILS market is the catastrophe bonds, also known as cat bonds. They are used by property insurers and reinsurers to secure their books from natural disasters, such as earthquakes and hurricanes, for example. This allows them to reduce their reinsurance costs while, at the same time, frees up their capital for new insurance businesses.
Cat bonds are designed in such a way that the payment of interest is made when a catastrophic event of predetermined magnitude strikes or one that causes aggregate loss when it comes to the damage done to the insured’s business.
Life insurance securitisation is another segment of the ILS market and arguably a better-known one. This form of securitisation performs the same function for life insurers as cat bonds do for property insurance companies, with the only difference being how the risk is approached and assessed.
While there are many more ILS segments out there, a new trend for investors might be brewing on Gibraltar.
Connection Between Insurance and Gaming Industry
For several years, Gibraltar has been a go-to base of operations for many companies and casinos that wish to enjoy favourable tax rates while reaping all the benefits of being licensed by the Gibraltar Betting and Gaming Association.
One of those companies is Lottoland, a well-known lottery provider that specialises in arranging bets on the result of the most popular world lotteries.
After securing the approval of the Gibraltar Financial Services Commission, Lottoland has become the first company ever to establish its own insurance firm. The gaming authority awarded Lottoland with insurance licences, after which the company founded Fortuna Insurance PPC Limited.
Lottoland first ventured in the ILS market back in 2015 with Fortuna 1. The €100 million deal was set to last for two years but was renewed in 2016 and provides the ongoing annual coverage as well as reinstatements. In time, Fortuna ISL transactions became the cornerstone of Lottoland’s advanced risk management system that provides coverage worth hundreds of millions and ensures that all players are paid out fully and in time.
Just recently, Lottoland has paid out a €90 million prize to the winner of the EuroJackpot from Germany via its Fortuna PPC subsidiary, which was an excellent way for ILS to showcase its use and potential in the gaming industry.
The Future of Insurance-Linked Securities
The existing ILS segments on the insurance market continue to expand. However, Lottoland’s usage of insurance-linked securities and their approach to solving their own problems while also bettering their service can potentially serve as an example for other companies to use ILS to their advantage.
Currently, ILS segments are available to a limited circle of investors, but as the market continues to grow, we might even see various businesses, such as those operating on the blockchain, for example, secure their property via ILS. Regardless of the direction the growth of ILS is headed in, both insurance and capital markets are excitedly waiting for new business opportunities.
