Dr. Marcel Grandi, Dr. Andreas Müller

Risk trading – More than just securitisation

The insurance-linked securities market opens up an attractive field of business for the insurance industry. It taps new sources of financing, increases transparency, and thus offers the opportunity to transfer single or multiple risks to the capital market - investors find them very interesting too.

Securitisations of insurance risks by means of insurance-linked securities (ILS) have increased significantly in recent years. At nearly US$ 5bn, catastrophe bond issues reached a new record in 2006. The outstanding capacity increased to US$ 15bn.

In life insurance, as much as nearly US$ 20bn has been securitised to date. Although this may appear rather low in terms of overall (re)insurance capacity, the international capital markets do offer almost inexhaustible potential. Market observers expect ILS to cover up to 20% of capacity for natural catastrophes in the medium term.

ILS becoming increasingly attractive

Several factors have enhanced the attractiveness of ILS. For example, the transaction costs of capital market solutions are lower today than they were even just a few years ago. The investors’ required return has also gradually decreased for usual securitisable risks.

This has come about as a result of increasing transparency, and as investors have consequently become more familiar with certain risks. In markets that work efficiently, we can therefore see a convergence between the pricing structure of the reinsurance and capital markets.

A further important role is played by professional risk management systems, which are becoming increasingly prevalent in the insurance industry. These support the development and establishment of new concepts of cover.

The insurance cycle also affects the ILS market: when capacities are scarce, alternative instruments become more attractive. However, these cyclical fluctuations cannot really mask the long-term trend, described by the Fitch rating agency as follows:

"The rise of alternative capital market solutions could constitute one of the defining elements of the long-term future of both life and non-life insurers and reinsurers."
(FitchRatings, Insurance Securitisation – Coming of Age, p. 1, December 2006)

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