For the global insurance industry, which deals primarily with risk, ongoing ingenuity and innovation are a dire need, today. For insurers and reinsurers which deal with the catastrophe lines of business, such as property-casualty, business interruption and others, the need to constantly innovate to meet the perpetually rising benchmarks that natural and manmade catastrophes are imposing on them, are particularly acute and pressing. Attaining incredible and unattainable levels of innovation has, therefore, become a way of life for them, and as a result of this, one sees new financial structures hitting the market with amazing regularity.
New generation reinsurance sidecars, that first appeared on the scene after 9/11 but gained popularity only after the onslaught of Hurricane Katrina in October 2005, are financial structures that are sponsored mainly by reinsurers to enable them to hive off part of their risks in specific lines of business, particularly catastrophe-related ones. Sidecars take on these risks of their sponsors for a premium, while sponsors are, in turn, paid a cession fee by the sidecars in addition to a mark-up by way of profit-sharing. How the concept of risk transfer through capital markets is gradually gaining popularity becomes evident in the sidecar mechanism. After assuming risk that the sponsors have hived off to them, sidecars float a separate fund for each risk assumed and throw open the fund to investors who contribute to the corpus. These investors, usually qualified institutional buyers (QIBs), get back their principal along with a profit mark-up in case there are no specified catastrophes during the tenure of the contract. Returns could go up to as high as 20-22%. In case there is an eventuality, the corpus goes towards claims payments and the investors lose all or part of their investments, depending on the volume of claims. |
