Shah: Data-driven cat bond can be replicated

Moving away from using traditional actuarial science and making risk more transparent could help to securitise more forms of insurance risk, said Ledger Capital Markets CEO Samir Shah.

The firm data scientists, as opposed to actuaries, to provide analysis of a $10mn private cat bond it did recently which was invested in by AlphaCat Managers.

The deal, covering non-standard passenger auto insurance, was announced in late January.

Auto bonds have been done before but not for this line of business. Generali did a liability motor ILS deal in 2016 while Axa did a series of Sparc auto profit securitisations before the financial crisis.

“The key to expansion into other risk classes is the ability to provide transparency and reliable assessment of the risk to investors who are not underwriters or experts in these areas”, said Shah explained.

This is done by leveraging mathematical techniques widely used outside of the insurance industry to make the risk more transparent by allowing, for example, back testing with integrity and ability to quickly compare and contrast strengths and weakness of different methods.

“Always hiring an actuary to model a risk is expensive and not going to lead to the commoditisation of the class”, said Shah.

“We are trying to leverage advanced statistical techniques in order to make the risk more transparent and we are trying to do this at scale”.

Greater use of securitisation can benefit insurance companies and investors alike, the former AIG executive argued.

Securitisation could enable insurers to split investors into two classes of investor – one group assuming all the risk of the company, including investment and strategic risk and expenses, while a second class only takes on pure insurance risk, which is completely uncorrelated to the capital markets.

 Always hiring an actuary to model a risk is expensive and not going to lead to the commoditisation” Samir Shah

“There is a huge value to the industry to separate these two things”, said Shah stated.

For the insurers, it could open up a much deeper pool of capital than the $5tn in the global life, health, and P&C insurance industry, while for the investor there is a broader range of investment opportunities.

Greater capacity, but importantly capital at a reasonable cost, would ultimately reduce the cost of insuring risk, said Shah.

Ledger is currently working on similar deals to the AlphaCat transaction. Shah has a strong belief that many other risks, such as long tail, life insurance and various classes of P&C risk could be securitised in this way.

The only risks that would be difficult to do in this manner are ones that are difficult to assess, for example, cyber and wildfire risk, said Shah added.

But while the aim is to use methods which can be applied to lots of portfolios, there is still room for adding in bespoke elements to transactions.

The AlphaCat auto deal included a variable funding mechanism whereby investment contributions will be made to match any increase in risk as the underlying auto insurance portfolio grows.

For a new product line that is small and growing, as was the case with this transaction, this was an important element to address.

The mechanism catered for the need of the investor not to take volume risk, but at the same time, met the needs of the cedant to ensure that they have capital when they need it as the risk ramps up, said Shah.

Shah founded Ledger in 2016 after leaving AIG, where he led their ceded reinsurance operations.

One of the goals of the company was to help the ILS market “look and feel more like other asset classes”.

The key to achieving this would be to give investors more transparency on the underlying risks and to bulk up the market’s size, Shah said.



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