Securitization - new opportunities for insurers and investors
No 7/2006
Insurance linked securities (ILS) provide insurers with a financing vehicle and a means of transferring risks to the capital market. They increase industry capacity, improve insurers’ return on equity, and reduce the volatility of earnings. For fixed-income investors, ILS provide an attractive rate of return that is not correlated with the rest of their portfolio. Structuring costs for such securities are coming down as the market grows rapidly.
The total volume of ILS outstanding has grown three-fold over the last five years, and is now close to USD 23 billion. Of this, two-thirds or USD 15 billion are life bonds, and the remaining USD 8 billion non-life. According to Swiss Re’s new sigma study “Securitization”, insurers and investors increasingly benefit from these new opportunities. Since total bonds outstanding are still just a small fraction of the potential market, issuance is likely to see strong growth going forward.
Transfer of life risks to capital markets
While life bonds are primarily a means of financing, some bonds do transfer substantial risk. Securitization to fund US regulatory reserves provides insurers with an alternative to letters of credit (LoCs). The bonds are a better match for the long duration of life policies and eliminate the re-pricing risk of short-term LoCs. Value of business inforce securitization is a financing method that unlocks the liquidity of future cash flows inherent in deferred acquisition costs and the present value of future profits. Extreme or catastrophic mortality bonds enable life insurers to hedge against risks such as a pandemic flu.
Transfer of non-life risk to capital markets
Most catastrophe or “cat” bonds transfer property and casualty insurers’ peak risks from wind and earthquake to the capital markets. They complement, and in some cases substitute for, other risk and capital management tools. Cat bonds represent about 85% of the current outstanding volume of non-life bonds. The remaining 15% is split between liability, credit, auto, and other miscellaneous risks.
ILS are an attractive investment for investors
ILS are typically uncorrelated with other bonds, so their addition to a portfolio will improve the portfolio’s performance while lowering its risk, thanks to diversification. Cat bonds yield a higher return than corporate bonds with the same rating, yet show less year-over-year volatility. The investor base for cat bonds has been expanding: in addition to insurance and reinsurance companies, more dedicated cat funds, hedge funds and traditional money managers are buying them.
ILS issuance is expected to grow rapidly
Less than 1% of the potential market for life bonds has been tapped so far. Survey results indicated that life bond issuance is expected to grow rapidly. The transfer of non-life risks to the capital markets represented only 6% of global property and casualty catastrophe reinsurance cover in 2006. The market for cat bonds is still nascent, and there is significant upside potential. The study expects the cat bond market to grow to USD 30–44 billion by 2016, as global cat reinsurance cover and cat bond penetration increase.
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Securitization – new opportunities for insurers and investors
Verbriefungen – neue Möglichkeiten für Versicherer und Investoren
La titulización: nuevas oportunidades para aseguradores e inversores
Cartolarizzazione – nuove opportunità per assicuratori e investitori
La titrisation: nouvelles opportunités pour les assureurs et les investisseurs
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For further questions please contact sigma@swissre.com.
