Industry Loss Warranty

What is 'Industry Loss Warranty'

An insurance or reinsurance contract in which coverage is triggered when the losses experienced by an industry exceed a specific threshold. Industry loss warranties (ILW) are most commonly written by reinsurance companies or hedge funds, since these organizations are able to absorb more losses than smaller insurance companies.

BREAKING DOWN 'Industry Loss Warranty'

Insurance companies may specialize in a particular line of coverage, and may underwrite policies in a limited geographic area. For example, an insurance company may write property insurance policies across the state of Florida. In most cases, the frequency and severity of claims is limited to small geographic areas, such as when a lake floods and damages a few homes. With catastrophes, however, the number of properties damaged and the extent of the damage can escalate quickly, potentially pushing the insurer into insolvency. To protect themselves from catastrophes, insurers may purchase an industry loss warranty.

Coverage in an industry loss warranty is typically triggered by a third party reporting that an event has occurred, rather than by the insured indicating that it has experienced a loss. This is because the coverage trigger is not based off of the experience of the insured, and is instead based on losses over a wide number of organizations. The trigger can also be linked to an index other than industry losses, such as the magnitude of an earthquake or the wind speed of a storm.

For example, an insurer underwrites property insurance policies across a state that is occasionally hit by hurricanes. Because hurricanes may damage the properties of a large proportion of its policyholders simultaneously, the insurer purchases an industry loss warranty with a $125 million coverage limit that is triggered when more than $10 billion in losses are reported from wind damage. If more than $10 billion in losses are reported from a hurricane, the insurer will receive $125 million.