Introduction Flashcards
Explain the risk transfer in insurance and reinsurance
3 levels:
- Primary Insurance: individuals and companies are looking to insure against different kinds of risk
- Then primary insurers pass on portfolios of similar risks or large single risks. Reinsurance reduces claims volatility and protect against extreme events
- Reinsurers may pass on risks to other reinsurers in the retrocession market. Insurance-Linked securities (ILS); transfer risks to investors in the capital markets
Insurance markets’ features ?
- (Re)insurers are highly leveraged and strictly regulated enterprises
-Underwriting cycle:
Soft markets: periods with excess supply of coverage and low premiums
Hard markets: periods with low supply of coverage and high premiums
What are the 2 main types of insurance risks ?
1) Property and casualty (non-life) risk:
- Property risk: damage caused by perils such as natural disasters
- Casualty risk: accident injuries and legal liability
2) Life and health risk
- Longevity/mortality risk: financial consequences of living longer/shorter than expected
- Health risk: potential for deterioration of one’s condition due to injuries or diseases
Explain the process of securitization
That’s a financial technique of pooling assets/risks and repackaging the cash flows into securities. It involves tranching of the securities to address different risk appetites.
What are the 2 common types of securitization ?
Asset-Backed Securities (ABS): mortgages, consumer loans, credit card receivables
Collateralized Debt Obligations (CDOs): corporate bonds/loans, credit default swaps, ABS
What are the Insurance-Linked Securities (ILS) ?
Financial instruments whose values are predominantly driven by insurance risks. Risk transfer for sponsors. ILS is classified as an alternative investment or even an own asset class.
ILS features ?
- Attractive risk-return profile: competitive expected returns and low volatility.
- Substancial diverification potential: low correlation with traditional asset classes.
- Excess spread over corporate bonds: novelty, illiquidity and sudden-death premium
What are the key distinction between ILS and securities issued by insurance companies ?
- Equity and debt securities of insurance companies are no “pure play” on insurance risk
- ILS may also contain market and credit risks, but are designed to minimize their impact
What are the ILS market participants ?
- Originators/sponsors: Typically (re)insurance companies which have underwritten the risk that is securitized. They cover themselves against losses by issuing ILS in the capital markets
- Modeling firms, medical underwriters and actuarial firms: Maintain huge databases as well as complex scientific or actuarial models. They quantify the underlying insurance risks to assess expected losses or life expectancies.
- Investments banks, reinsurers and reinsurance brokers: Arrange and structure ILS deals before placing them through their sales forces.
- Capital market investors: Provide risk capital to the sponsors by purchasing ILS for their porfolios
What are the 4 key risk management challenges in the 21st century ?
1) Protection gaps
2) Demographic Change
3) Climate Change
4) New Extreme Risks
Major reasons for the advent of ART ?
- Magnitude of catastrophe risk and longevity risk
- Reinsurance capacity limits, especially during hard market
- Classical contract constraints (single year, peril, trigger)
- Technological advances in data collection and risk modeling
- Increasing frequency and severity of disaster losses
- Growth of insured property values in exposed areas
