Insurance-Linked Securities (ILS)
Insurance-linked Securities (English Insurance Linked Securities, ILS) are interest-bearing securities, which pay claims against a special purpose vehicle (English Special Purpose Vehicle, short SPV) have as their object, and wherein the SPV funds used to purchase insurance risks exclusively through reinsurance agreements and securitized to a securities. Seller of the receivables in such a transaction are usually insurance companies that make such parts of their insurance risks tradable in order to raise money. At this asset class include catastrophe bonds, life bonds and collateralized debt obligations.
- 4.1 Sponsors of ILS transactions
- 4.2 rating agencies, and bond insurers Risikomodellierer
- 4.3 Investors in ILS
- 4.4 arrangers of ILS
- 4.5 auditors and supervisory authorities
- 4.6 Lawyers
General
With the securitization of risks by means of insurance-linked securities, the insurance industry has since the early 1990s on new areas of risk management and refinancing. The volumes have grown steadily over the years until the intensification of the financial crisis in 2008. Risks from disasters and mortality changes and negative contributions from newly developed business units were transferred to the capital markets. Future premiums rivers were financed through securitization and allow the insurance companies a more efficient allocation of capital.
Methods of risk transfer
The insurance industry has a wide array of business types to cover risks. Some types of risk such as Counterparty risk, credit risk and mortgage risks are also taken in one form or another of banks. Other types of risk such as mortality, longevity or disasters are insurance -specific and outside the insurance sector rather unknown.
For risk transfer are the traditional methods of reinsurance and retrocession available. Alternative risk transfer was also developed in recent years with various instruments. Alternatively, the transfer of risk is always when he does not take place as with traditional methods within the insurance sector, but between insurance companies and the capital market. A branch of the alternative risk transfer, the insurance securitization.
Types of Insurance Linked Securities
ILS in the property insurance
Catastrophe bonds are the most familiar form of securitization in property insurance. They cover next storm and earthquake risks caused by natural disasters and human catastrophe losses from. Recent innovations are beyond the securitization of auto insurance and coverage for credit risk portfolios.
ILS in the life insurance
Differences are in the life insurance segment (Life Bonds ) the securitization to cover U.S. reserve requirements, the pre-financing of income and risk transfer. The securitization of the purchase of life insurance policies on the secondary market ( life settlements ) is another form of life insurance securitization.
Collateralized Debt Obligations
As a special form of securitization are insurance -linked collateralized debt obligations. In addition to subordinated bonds of insurance companies reinsurance receivables and risks of catastrophe bonds were bundled and securitized.
The stakeholders in the securitization process
Sponsors of ILS transactions
As sponsors (in the sense of initiators ) for ILS contact insurance companies but also on a reinsurer on the market. Motivations are to decide on the form of an insurance securitization in addition to the risk transfer, capital saving or opening up new groups of investors. The control of the insurance and investment risks by means of asset liability management. Duration and convexity are important measures in this context. To raise capital hybrid bonds are issued by collateralized debt obligations.
Rating agencies, and bond insurers Risikomodellierer
Rating agencies, and bond insurers Risikomodellierer ( monolines ) called for a standardization of markets in order to be able to present their services effectively a. Rating agencies assess the likelihood that the structures will make its interest and principal payments properly. Risikomodellierer assess the likelihood of a loss occurring and its height. Monoline afford additional collateral in the form of insurance of interest and principal payments of the securities.
Investors in ILS
Traditional fixed-income investors receive from their investments in ILS the opportunity to invest in new asset classes, insurance -linked risks that are virtually uncorrelated with other investment instruments. In the context of modern portfolio management Risiko-/Ertragsgesichtspunkten while having a high priority. Sufficient diversification Default risks are scattered. The design of triggers (payment triggering mechanisms in case of damage ) have an influence on the yield of the structures. In connection with the design considerations of trigger mechanisms, the terms hazard (subjective risk) play asymmetric information, adverse selection ( adverse selection ) and moral a special role.
Arrangers of ILS
As arrangers of insurance securitizations, in addition to banks in their role as financial intermediaries and insurance and reinsurance occur. In addition, for large insurance brokers capacities were created for placement. The pricing of insurance securitisations, especially compared to traditional reinsurance plays a central role.
Auditors and supervisory authorities
The systems in Europe and the U.S. are very different with views of the accounting and insurance supervision. To assess the risks of VaR (Value at risk ) and the expected shortfall (the expected loss ) are important metrics.
Lawyers
Lawyers involved in the preparation of contract documentation. You have contact with almost all stakeholders and therefore a very good overview of the securitization process.
Simplified diagram of an ILS transaction
Phase 1: The primary insurer ( sponsor) opts for the transfer of risks of ILS and establishes a reinsurance special purpose vehicle ( SPRV, English Special Purpose Reinsurance Vehicle. )
Phase 2: The sponsor transfers the portfolio by entering into a reinsurance contract with the SPRV
Phase 3: The SRPV commissioned a bank ( possibly assumes the risk of placing the bonds by an underwriting bank ) with the issuance of bonds
Phase 4: The bonds will be placed on capital market investors and the proceeds paid into a trust deposit, which is managed by a trustee. The Trustee may buy with the cash securities in order to achieve a higher return
Phase 5: Interest and repayments of securities account balance will be secured by a bank, through a total return swap. The Bank also guarantees the timely payment of interest on the ILS bonds to investors (usually USD Libor risk margin )
Phase 6: If there is no event by which the bond will fall due ( trigger event ), the principal is repaid at maturity to the capital market investors
Phase 6b: If a Trigger Event, losing investors according to the contract with which they have been involved in the structure of a part or all of the assets
Effects of the financial crisis
The collapse of the investment bank Lehman Brothers and the subsequent financial crisis weaknesses of ILS came to light with which the actors had not counted on the financial markets ( Lehman Brothers was involved as arranger, underwriter, total return swap partner and investor in the ILS market). Problem areas are:
Phases 1 and 2: If sponsors (such as AIG in difficulty ) will continue to manage the stocks as the other businesses of the sponsor. The supervisory authorities have a duty to protect the interests of policyholders.
Phase 3: The banks, which deals with other problems an underwriting were, at times barely able to represent. The market for insurance securitisations was disturbed in the second half of 2008, and which, although very few new issues have been placed, but the secondary market trading took place and continue with few losses in value. In 2009, not only renewal transactions, but also new business in the market have been placed. The market returns since 2010 back to normal.
Phase 4: The willingness of investors to buy ILS, especially against the background that the returns on investments temporarily earn higher returns in corporate bonds of comparable credit quality declined not essential since ILS have very low correlation with other asset classes.
Phase 5: If the bank that has committed in total return swap to compensate for losses, gets into trouble, the business foundation for the entire securitization at risk. What is needed is a strong increase in the credit standards of the Total Return Swap banks is necessary. It required minimum ratings of the quality of AA.
Phase 6: The USD - Libor rates were temporarily increased sharply during the crisis a very volatile pattern and are. As a result, less volatile rates were set for short-term government securities as the basis for some transactions.
Through their misperceptions of the credit quality of mortgage backed securities mortgage securitization, the rating agencies are also come under strong pressure. Through a strong separation of risk assessment from mandating stricter standards and investor confidence is to be recovered.
Market for ILS
Due to the very low correlation with other products, the prices of ILS have remained stable even during the financial crisis. The Fukushima nuclear disaster has indeed led to a loss of three bonds, the growth of Emissionsvoluina and the market values of other ILS but hardly affected.
Securitizations to cover U.S. life insurance reserve requirements were increasingly unattractive by eliminating the monolines. Most of monoline insurance companies are strongly advised in the financial market crisis under pressure or completely failed. No guarantees are currently obtained for the long-running life insurance ILS. Thus, the structures were unattractive due to their complexity for investors. To hedge against longevity risk collateralized swap structures appear with banks currently more attractive than securitization. As before, mortality risks are hedged about ILS on a small scale.
In addition, insurance companies must meet minimum requirements as regulated companies to capital. It is expected that ILS techniques with the introduction of Solvency 2 regulatory reforms in Europe will reach a higher place in 2012.
Swell
- Christopher L. Culp. The ART of Risk Management: Alternative Risk Transfer, Capital
- Structure and the Convergence of Insurance and Capital Markets. Wiley, New York, NY, 2002, ISBN 0471124958
- Christoph Weber, Insurance Linked Securities - The Role of the Banks, Gabler, Wiesbaden, 2011, ISBN 9783834928603
Further literature
- Erik Banks, Alternative Risk Transfer: Integrated Risk Management through insurance, reinsurance, and the capital markets, Wiley, Chichester, 2004, ISBN 0470857455
- Peter Liebwein, Classical and Modern forms of reinsurance, VVW, Karlsruhe 2000, ISBN 3884877941
- Mischa Knight, hedge catastrophe risk to capital markets: A critical survey, Gabler, Wiesbaden 2006, ISBN 3835003348