Cyber seems to be close to everyone's thoughts at the moment. At a time that the markets are seeking new business to write with their overcollateralised balance sheets and ILS funds are seeking new products to invest in that are not US hurricane and earthquake, many are turning to cyber. So how well does cyber fit the insurance model?
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Today investors in certain ILS structures are cosily told about the risks that they will assume – non-correlated to the capital markets, well selected, well modelled and part of a well-diversified portfolio. Whereas it is doubtlessly explained that events can and periodically do occur, investors see from recent years that this is infrequent and the returns appear good.
Solidum has again profited from trading in distressed Cat Bonds, this time it was the Multicat Mexico C tranche. Through superior and timelier knowledge Solidum was able to purchase a few million of the notes at 20 cents for them to increase in value to close to 50 cents after a few hours, ultimately maturing at 50 cents shortly thereafter.
Casting one’s mind back to the heady premium days of post Katrina / Wilma, life for the reinsurance market, including the nascent ILS market, was good. It was what in the industry is called a ‘hard market’, a market where terms are hard i.e. high premiums combined with narrow coverage scope. Premiums had sky-rocketed and capacity remained fairly scarce. Once they had put to work their own capital, enterprising reinsurers pondered how to continue to capitalise on this boom time.
Cat bond market as a proxy for the general ILS market:
Northern Rock started of life in the mid-1800s as a UK building society, providing savings and mortgages. As with many building societies in the 1990s it became a bank. It continued to provide mortgages for its customers financing itself in the capital markets. In 2007 it shot to fame as becoming the first UK bank in living memory to have a run on it following it approach to the Bank of England for a loan facility.
Prior to 2008 the standard Cat Bond collateral structure was using a total return swap (“TRS”) with the structuring investment bank. The investment bank invested the collateral into securities of their choice, subject to certain constraints, and swapped the interest rate into LIBOR and guaranteed repayment. Over time and little by little the collateral security requirements were weakened, as with all structured finance products, and the investment banks had greater scope. A cynic may say that the investment banks were given cheap rolling finance from the TRS product.