How insurance risk is transformed into investable assets
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Re: How insurance risk is transformed into investable assets
#2[dead]
Re: How insurance risk is transformed into investable assets
#3I've asked two financial advisors about CAT bonds. One had never heard of them and the other said were about as risky as crypto. I guess this is such a niche product that there isn't widespread knowledge about it.
I wonder how much more diversified $ILS could be if it were larger. Would a 10x increase in assets under management give it significantly less volatility because it could do a better job spreading risk around the globe?
Re: How insurance risk is transformed into investable assets
#4There are a lot of interesting dynamics in this market.
For example, CAT bonds are generally tied to the specific natural hazard ("this bond triggers if a hurricane of Category 3 or higher land falls in this segment of Florida") or to industry losses, as estimated by an agreed upon source.
This means that a CAT bond is correlated with, but not directly informed by an insurer's actual loss experience. Traditional reinsurance (so an insurer themselves getting insurance) will usually be tied to specific policies, so their experienced loss is what determines payout.
However, depending on the insurer's policies, traditional reinsurance may be unavailable or much too expensive (either due to the large limit needed, the risk level of the policies, or any number of other reasons). Depending on the trigger, a CAT bond can also pay out faster because you don't have to wait to see the claims from 100k home insurance policies.
From the technical side, most large reinsurers license CAT modeling software from one or both of the same two vendors: Moody's RMS or Verisk. The biggest reinsurers will develop their own models, and there are other modeling vendors that they may license for particular perils (EQEcat for earthquake and KatRisk for flood come to mind), but the big two are pretty widely accepted in reinsurance markets.
That means if your policies are "odd" in some way (uncommon construction type, power facility, etc.), depending on how a reinsurers chooses to model them (or how the model specifically handles them) can have a big impact on your reinsurance pricing. If you know something about your policies that can't be incorporated into a vendor model very well, you may get better pricing on a CAT bond.
These are just some of the considerations! There are so many more things that go into it. But I think it's super interesting to think about.
Source: I work in this side of the industry, specifically in natural catastrophe modeling.
Re: How insurance risk is transformed into investable assets
#5Blown away by the traffic from this post!
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Re: How insurance risk is transformed into investable assets
#6There are a lot of interesting dynamics in this market. For example, CAT bonds are generally tied to the specific natural hazard ("this bond triggers if a hurricane of Category 3 or higher land falls in this segment of Florida") or to industry losses, as estimated by an agreed upon source. This means that a CAT bond is correlated with, but not directly informed by an insurer's actual loss experience. Traditional rein…
Correct on every point and great insight, hello fellow insurance person.
I will clarify that CAT bonds can have industry loss triggers OR actual indemnity triggers. If an indemnity trigger then the insurer has to prove the actual loss. But you’re right on ILWs (Industry Loss Warranty) in that there is additional model/basis risk considerations.
Insurance companies try to minimize this basis risk. Because while sure it’s great to be in the situation where your CAT bond recovers when you didn’t have large losses, it’s NOT good to be in the position where you had big losses and you don’t recover. Certainty of recover can affect things like how much regulatory credit you get for your reinsurance.
Re: How insurance risk is transformed into investable assets
#7I've asked two financial advisors about CAT bonds. One had never heard of them and the other said were about as risky as crypto. I guess this is such a niche product that there isn't widespread knowledge about it. I wonder how much more diversified $ILS could be if it were larger. Would a 10x increase in assets under management give it significantly less volatility because it could do a better job spreading risk arou…
The lack of information was my inspiration for building Riskvest. I called my own broker and when I said catastrophic bonds they asked if I meant buying bonds already in default.
On the risk side - your comments here are part of the myth I’m trying to dispel and will have lots more to say in future posts.
Yes for a single CAT bond you are exposed to potential 100% principle losses. But if you buy a bundle of CAT bonds that focus on say California Earthquake, Florida Hurricane, Japanese Typhoon, and a Cyber Event, you can imagine the diversification benefit you get there.
I’ve already created a very very simple model for people to play around with and learn the intuition for CAT bond return patterns. A default means 100% loss and this is unique vs. other bonds. I plan in the future to build a much more robust model.
https://www.riskvest.io/data-lab/cat-bond-portfolio-simulato...
Re: How insurance risk is transformed into investable assets
#8I've asked two financial advisors about CAT bonds. One had never heard of them and the other said were about as risky as crypto. I guess this is such a niche product that there isn't widespread knowledge about it. I wonder how much more diversified $ILS could be if it were larger. Would a 10x increase in assets under management give it significantly less volatility because it could do a better job spreading risk arou…
CAT bonds are typically restricted to institutional investors. I would be very surprised if you could even buy one without being a QIB.
Re: How insurance risk is transformed into investable assets
#9I've asked two financial advisors about CAT bonds. One had never heard of them and the other said were about as risky as crypto. I guess this is such a niche product that there isn't widespread knowledge about it. I wonder how much more diversified $ILS could be if it were larger. Would a 10x increase in assets under management give it significantly less volatility because it could do a better job spreading risk arou…
CAT bonds are typically restricted to institutional investors. I would be very surprised if you could even buy one without being a QIB.
New opportunities for retail investors have been popping up lately! That’s a big part of what Riskvest is meant to document.
Re: How insurance risk is transformed into investable assets
#10Would you consider a followup post about reinsurance assets targeted to derisk potential systemic or liquidity risks in the entire CAT bond market?