The securitisation of insurance risk

Document description

In 1992 the Chicago Board of Trade launched a series of insurance futures and options contracts. These are based on indices linked to the incidence of natural catastrophes in specified regions of the USA. At the time, this was hailed as a major and revolutionary development within the insurance industry. However, although trading volumes in these contracts have picked up in recent months, volumes remain relatively limited, apparently because there are currently more natural buyers than sellers of such instruments. There were then few major developments in securitisation until 1995. However, during the last two years, several insurance entities have issued a diverse range of investment instruments where the investment return is linked in some way either to the incidence of insurable events or the performance of an insurance portfolio. Instruments which have been launched or proposed include: 1) Catastrophe bonds, where the return on the bond is linked to the incidence of natural catastrophes. 2) The securitisation of an individual insurance portfolio, where the return on an investment instrument is related in some way to the profitability of insurance business written within the portfolio. 3) Contingent capital facilities, where the issue of debt or equity capital is linked to the incidence of natural catastrophes or the performance of an insurance portfolio. In some cases, the provision of capital is not dependent on the prior occurrence of an insurance event. Against this rapidly changing background, the Working Party has produced this paper with the following objectives:- 1) to explain why there has been an increasing level of interest in the securitisation of insurance risk. 2) to describe the more significant investment instruments which have been launched or proposed in the last two years. 3) to analyse these instruments, and to discuss their individual advantages and disadvantages. A substantial proportion of the early issues failed or were withdrawn, and we explore in this paper why this was so. More recent issues have met with a greater degree of success. 4) to suggest possible future developments which may take place during the next few years in the area of securitisation of insurance risk. In particular, we consider whether or not, as some people suggest, securitisation will fundamentally change the way insurance and reinsurance are written.