Insurance-linked securities (ILS) are already bouncing back from a tough sell, Michel Liès, the head of the client markets business function at Swiss Re says.
After the subprime debacle in the United States, in which bad mortgage debt was bundled and sold as securities to investors, "securities" generally were often perceived to be a problem rather than as a profitable financial solution.
Sales of insurance-linked securities (ILS) lagged for six to nine months in 2009, in part because of bad press related to subprime, but the market is already rebounding, Liès says.
"It took a little bit of a hit, but already in 2009 it is coming back," he said. "There is an enormous difference between the classical asset-backed securities that you see [in the news] and the insurance-linked securities.
"[Reinsurers have] never hidden the fact that if you want high returns [with ILS], there is high-risk. And in insurance-linked securities, the high risks are clearly identified."
For investors, the "honesty" inherent in insurance-linked securities is based on several factors, Liès says.
One is that ILS is not directly correlated with the ambiguous fortunes of the financial markets. Instead, risk associated with ILS is typically predicated on natural events.
Second, using parametric forms of ILS, investors can calibrate the risks they agree to finance. For example, investors can buy ILS products in which the risk can be defined clearly in terms of wind speeds, seismic quake readings and precipitation counts.
In a recent innovation, investors can now buy ILS linked to pandemic outcomes, Liès says.
The key is that the risk is clearly identified in all of these catastrophic events, Liès said. This lends a certain level of honesty in ILS that is not always present with asset-backed securities.
With ILS, "we've spent 10 years building the basement, and now we're building a good building on that solid basement," Liès says. "Some of the asset-based securities, they are building a cathedral on sand….
"I think people understand that there is definitely a big difference. The risk [in ILS] is clear."