Investing in Insurance Risk
Covers cat bond pricing and the investor case for the asset.
Summary
The reference has not verified this book in detail; the summary states only what the title, author and subject establish.
Krutov, an actuary and consultant, wrote a practitioner treatment of insurance-linked securities and other instruments that transfer insurance risk to capital markets. The reference has not verified the detail of the chapters.
The subject covers a set of instruments with a common logic. Insurance and reinsurance risk, particularly natural catastrophe exposure, is largely uncorrelated with equity and credit markets, which makes it attractive to investors seeking diversification, and the capital markets can absorb amounts of catastrophe exposure that the reinsurance industry's own capital cannot. Catastrophe bonds transfer defined event risk to bondholders who lose principal if the trigger is met, with triggers structured as indemnity based on actual losses, as industry index, as parametric based on measured physical characteristics of the event, or as modelled loss. Sidecars give investors a quota share of a reinsurer's book for a defined period. Industry loss warranties pay on aggregate industry losses. Life-side instruments include mortality bonds, embedded value securitisations and life settlements, where a policy is purchased from the insured at a discount to face value.
The analytical requirements are specific: catastrophe modelling supplied by a small number of vendor firms, basis risk between the trigger and the sponsor's actual loss, and the fact that historical data on rare events is thin by definition.
The market has grown substantially since 2010 and has been tested by the 2017 hurricane season, the California wildfires and subsequent events, which produced losses and repricing. Readers should verify current market structure and pricing conventions against current sources.
Key takeaways 7
- Natural catastrophe risk is largely uncorrelated with financial markets, which is the basis of the asset class's appeal to investors.
- Catastrophe bonds transfer defined event risk to investors who lose principal when the specified trigger is met.
- Trigger design determines basis risk: parametric triggers pay quickly but may not match the sponsor's actual loss, while indemnity triggers match but settle slowly.
- Catastrophe models supplied by a small number of vendors determine pricing, so model risk is concentrated across the market.
- Sidecars give investors a quota share of a reinsurer's underwriting for a defined period, which is a simpler structure than a bond.
- Historical data on rare catastrophic events is thin by construction, so pricing rests on models rather than on experience.
- Life settlements depend on mortality estimates for individuals, and errors in those estimates have repeatedly damaged returns.
Who should read it
Allocators and practitioners considering insurance-linked securities who need the instrument structures and risk considerations, verified against current market conditions.
Where it sits in the reference 3
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