ILS History
Insurance Linked Strategies - history

The first insurance-linked instruments with standardized terms and conditions, known as Catastrophe Bonds (Cat Bonds), were issued in 1994 and transferred a specified set of risks from a sponsor to investors. They emerged in the wake of Hurricane Andrew and the earthquake in Northridge (California) in the early 1990s.

The large insured losses emerging from these events exposed large gaps in the underlying capital base of insurance and reinsurance companies, and raised the question of capital adequacy within the industry. It was apparent that a new source of capital with a higher capability of absorbing large losses was required. The capital market fulfilled this requirement due to its size and depth. 

Given the low entry barrier and the low correlation to other financial instruments, Cat Bonds gained a lot of attention in the capital market. To date, more than 400 Cat Bonds (including matured Cat Bonds) have been issued, and the Cat Bond market has grown to approximately USD 28 bn (as of June 2020, excluding mortgage, life and private Cat Bonds, source: Credit Suisse).

After 2003, the capital market also became increasingly active in the traditional reinsurance market through what are termed “ILS Private Transactions“. This new risk transfer instrument offered much broader access to the reinsurance market and significantly improved the diversification potential of ILS.

The growing convergence of the capital and insurance markets offered investors the opportunity to gain direct exposure to (re-)insurance risks not just through reinsurance equities, whose performance is more driven by investment results than the actual reinsurance business, but also through dedicated alternative investment strategies.

Following the financial crisis in 2008/2009 in particular, when ILS proved its low correlation to the financial markets, investors’ interest in this asset class grew significantly. The low-interest-rate environment has further driven the influx of capital into the ILS market.

Since the 1990s, the alternative risk transfer market has grown from barely USD 2 bn to around USD 100 bn, and now represents over 15% of the global dedicated reinsurance capital (as of March 2019, Source: Aon Benfield).

Most of the alternative capital is deployed in developed insurance markets, which are vulnerable to natural catastrophe risk; particularly the US, followed by Japan, Europe, Australia/New Zealand and other smaller insurance markets globally.