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Insurance-Linked Securities

Investing in insurance

At the crossroads of fixed income and insurance

Insurance-linked securities (ILS) are financial instruments, the value of which is derived from insurance loss events. They are available in a tradeable format as bonds or as private contracts and are issued by a special purpose vehicle (SPV) that converts a (re)insurance contract into investable securities.

How it works

On one side, the SPV enters into a contract with a (re)insurance company receiving a premium for taking on some form of insurance risk. On the other, the SPV issues securities that are purchased by investors who in turn get the insurance risk premium from the SPV. Investors also receive some form of money market return given that the transaction is fully collateralised and this security collateral is invested in-short term or overnight assets. 

By adding ILS to a portfolio, investors can benefit from a diversifying risk premium that generates potentially attractive returns that are not correlated to the economic cycle.

An emerging alternative asset

An ILS is known as a principal-at-risk security. If a major insurance event takes place, then the issuing SPV may not repay the principal so that it can instead fulfil the (re)insurance obligations to the protection buyer.

ILS mainly cover non-life and, to a lesser extent, life risks. On the non-life side, the main risks are natural catastrophes, such as hurricanes, earthquakes or winter storms. There are also some marine, aviation, mortgage insurance and terrorism exposures being transferred into capital markets. Embedded value, extreme mortality and healthcare risks are covered on the life side of the ILS market.

 

  Benefits to investing in ILS:

  • Improved portfolio diversification and low volatility compared to other capital market investments.
  • Potentially attractive returns and stable return pattern at portfolio level.
  • Non-life ILS are low-duration floating rate instruments, while life ILS offer medium- to long-duration with an attractive illiquidity premium and risk-return profile.
  • Growing demand for ILS means increased opportunities for investors and better diversification within the asset class.

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Risk warnings
Past performance is not a guide to future performance and may not be repeated.
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
Alternatives can be more volatile than shares and bonds, and it may be harder to cash in the investment at short notice. Private Assets offer less liquidity than publicly listed securities. Please note: this is not a complete list of risks but rather an overview of some risks.
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