Until recently, most insurance risks were inaccessible to capital market investors, despite their many benefits over other assets. The alternative risk transfer (ART) market, which allows insurers to lay off exposures to capital market investors, has provided the insurance market with extra capital. But this market has been dominated by catastrophe risks, losses from which have been rising in recent years, which has caused investor appetite to cool.
Many life and P&C risks, such as motor, longevity and mortality risks, are, however, high frequency, low severity in nature, and therefore ideal for data-driven, predictable investment returns. They offer institutional investors stable, uncorrelated returns that also diversify their portfolios.
Innovative Approaches to Insurance-Linked Investments
Asset-based collateralization isn't new in the financial markets, but this is the first time it has been used in the ART market, where most investments require capital.
ART providers have explored innovative methods to boost liquidity and the flow of reinsurance capital, especially in underserved areas. The development of new actuarial methods, such as AI-based risk modeling, have significantly improved the risk models’ accuracy, which has enabled more accurate, transparent and standardized risk transfer to capital market investors, attracting new participants and creating a new source of capital markets capacity for the insurance sector. Furthermore, these technologies’ objectivity and accuracy open these assets to being rated by agencies, which will make this asset class even more appealing to more investors.
Pooling portfolios could also creatre extra liquidity in the market, as deals can be structured similarly and distributed together to a wider audience, while also significantly lowering tail risk. Capital market investors can benefit from significantly lower risks while investing in multiple, diversified reinsurance deals that are "translated" into their language.
Using Existing Assets to Earn BB Spread of AA Uncorrelated Risk
Vesttoo has gone one step further, launching the first ART vehicle which pools reinsurance deals and allows investors to use existing assets as collateral, without the need to allocate cash. Asset-based collateralization isn't new in the financial markets, but this is the first time it has been used in the ART market, where most investments require capital.
TheInsurance-Linked-Program (ILP) lets investors pledge high quality assets, such as corporate or government bonds, as collateral for reinsurance deals, earning additional spread from existing assets. This facilitates our global alternative reinsurance pipeline while providing investors with structural alpha, and a very attractive risk/reward profile due to strict diversification guidelines and pooling, which almost eliminates tail risk (the chance to lose 10% of portfolio).
These innovative approaches make non-catastrophe insurance-linked investments increasingly attractive to institutional investors. Given the huge funding gap in the insurance and reinsurance sectors, the alternative risk transfer market for plain-vanilla life and P&C risks is set to grow significantly. According to the European Insurance and Occupational Pensions Authority (EIOPA), despite initially bouncing back towards the end of 2020, the (re)insurance sector will continue to feel the repercussions of the pandemic for years to come, so this asset class is here to stay. The application of advanced technology and creative financial engineering will prove to be a win-win for everyone involved.
