Industry loss warranties (“ILW”) are a form of insurance-linked security used to finance peak, non-recurrent insurance risks, such as hurricanes, tropical storms and earthquakes. The distinguishing characteristic of ILWs is the use of an industry loss index, that is, the payout is dependent on loss suffered by all insurers in connection with a catastrophe event and not just the loss of the insured. This feature allows instruments to
be created and sold on short notice as the parties are only required to diligence the index. In addition, this narrow focus on the index promotes standardization, liquidity and price transparency. ILWs are part of a non-correlated asset class like other insurance-linked securities but are not burdened by the same illiquidity and high transaction costs. As available indices and data quality improves, ILWs offer more nuanced coverage and reduce their traditional weakness, basis risk.
This article broadly explains ILWs: the most common forms; the reasons why re)insurers and investors are attracted to ILWs; shortcomings of ILWs; how ILWs are legally structured and regulated.
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