A synthetic approach
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A synthetic approach

Insurance-linked securities offer safety in numbers

In tandem with the growth of the insurance-linked securities market itself, many are forecasting a sharp increase in the volume of insurance-linked derivatives. These tend to take the form of catastrophe swaps – which are essentially synthetic ILWs. Insurance derivatives could draw more insurance companies into the market, as proponents argue that they will replicate cat bonds but at a fraction of the cost (see Insurance and capital markets converge, Euromoney, April 2008). The joint venture between interdealer broker Icap and Jardine Lloyd Thompson has been hailed as the way forward for the market. "Insurance companies are trying to find alternative means to hedge risks," says John Dziadzio at Lehman Brothers. "Traditional reinsurers have now realized that capital markets distribution is the way forward. It is very interesting to see brokers entering into joint ventures with derivative platforms as this is business that they would traditionally get fee income for. But they can see that this is the future."

The Icap/JLT venture is the latest in a series of initiatives to exploit new ways of hedging insurance risk synthetically. In November 2006, for example, Deutsche Bank launched its proprietary event loss swaps (ELS), which are essentially credit derivatives based on US wind or earthquake risks.

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