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Industry loss warranties (ILWs), are a type of reinsurance contract used in the insurance industry through which one party will purchase protection based on the total loss arising from an event to the entire insurance industry above a certain trigger level rather than their own losses.[1]
For example, the buyer of a "$100million limit US Wind ILW attaching at $20bn" will pay a premium to a protection writer (generally a reinsurer but sometimes a hedge fund) and in return will receive $100million if total losses to the insurance industry from a single US hurricane exceed $20bn. The industry loss ($20bn in this case) is often referred to as the "trigger". The amount of protection offered by the contract ($100million in this case) is referred to as the "limit".
ILWs could also be constructed based on an index not linked to insurance industry losses. For example, Professor Lawrence A. Cunningham of George Washington University suggests adapting similar mechanisms to the risks that large auditing firms face in cases asserting massive securities law damages.[2]
These agreements are usually documented as reinsurance contracts between the parties but can also be described as financial derivatives. If so, in addition to the industry loss trigger the contract will include an "ultimate net loss clause" which specifies that the protection buyer must demonstrate that they have lost a specified amount as well. ILWs are sometimes referred to as original loss warranties or Original Market Loss Warranties, but this usage is becoming increasingly rare.
^Iranya Joseph (November 13, 2017). "Understanding Industry Loss Warranties (ILW's)".
^Lawrence A. Cunningham, Securitizing Audit Failure Risk: An Alternative to Damages Caps, William & Mary Law Review (2007)
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