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Bermuda:Re+ILS Spring 2016

aren’t necessarily consistent between the two types of risk transfer. Rather than cannibalise the catastrophe bond space, the cat bond lite market should be seen as a source of overall ILS market growth, with the potential to engage new cedants and generally expand the sector’s base. As with any form of risk transfer in this sector—including collateralised reinsurance and ILWs—it’s important to remember that the expansion of available tools has been fuelled by the need to address specific cedant and capital provider objectives with increasing precision. Cat bond lite provides several salient benefits for transactions involving ILS funds, including: • Securitisation to address the liquidity mandate; • Frictional cost management; • Speed to market (lites can be completed in as few as 10 days); and • Flexibility of structure (for example, trigger type). The advantages of cat bond lite clearly address scenarios in which a transaction involving a fund need to be completed with minimal cost and time while still aligning with the benefits of the underlying structure (for example, ILW or collateralised reinsurance). As a result, future innovation regarding transaction efficiency should provide better ways to meet the objectives currently served by lites. Conventional thinking would call for the further reduction of frictional costs in cat bond lites, but the next step in efficiency innovation probably shouldn’t be a cat bond lite at all. Rather than thinking about the future of this structure, the market should focus on how to complete faster and more streamlined risk transfer 47 Spring 2016 Bermuda:Re/insurance+ILS transactions in the capital markets space, regardless of the vehicle used to accomplish it. And that means getting ready for exchange-traded catastrophe options. Exchange-traded cat For more than 25 years, the re/insurance industry has sought a way to trade index-triggered binary catastrophe options in a liquid, regulated environment. For many reasons, past efforts weren’t able to gain traction. With the advent of cat bond lite—and a ready fund-to-fund market to act as a first wave of adoption—it’s evident that conditions have changed and that an exchange-traded risk solution can thrive. Of course, an exchange-traded catastrophe risk solution would not completely replace the cat bond lite market. After all, there’s likely to remain a need for parametric- and indemnity-triggered lites. Some counterparties may even prefer to complete some index-triggered transactions in the lite format (rather than in exchange-traded option format) for reasons such as protecting proprietary or strategic information or because they want to work with certain counterparties in a more private environment. Nonetheless, exchange-traded risk would provide a more efficient and cost-effective approach to index-triggered risk transfer, equipping risk-bearers of all kinds with a new tool for optimising capital allocation and creating shareholder value. With this in mind, perhaps the future of cat bond lite should be rather short. After all, creative destruction is the spirit of innovation. ��


Bermuda:Re+ILS Spring 2016
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