Question

What is collateralized reinsurance and why would it be used?

Answer 1

Collateralized reinsurance refers to a reinsurance contract or program which is fully-collaterized, typically by investors or third-party capital. The collateral is put up by investors or third-party capital providers to cover in full the potential that could arise from the reinsurance contract.

Normally the collateral posted is equal to the full reinsurance contract limit, minus the net premiums charged for the protection.

Collateralized reinsurance allows ILS funds, hedge funds, pension funds and unrated, third-party capitalised reinsurance vehicles to participate in major reinsurance programs as the contracts they write are fully-collateralised. By participating in collateralized reinsurance activities these investors and capital providers are able to provide capital to underwrite insurance risk without requiring a rating, thus enabling them to receive the premiums as a return on their invested collateral.

The market in collateralized reinsurance enables these institutional investors to directly participate in the reinsurance market and provide a source of risk capital to cedents in the market. This risk capital is increasingly popular as it helps a cedent diversify its sources of reinsurance protection and due to the fully-collateralized nature of the covers.

Some people talk about collateralized reinsurance investments (“CRI”) as privately structured securities or derivative transactions which enable investors to access the return of the reinsurance market and again provide risk capital on a fully collateralized basis. CRI are typically more customizable but less liquid investments than catastrophe bonds. CRI are often coreated by taking reinsurance contracts and transforming them using an offshore entity into securities which are bought and so collateralized. This side of the market is growing and allows investors to access much broader classes of insurance risk should they choose.