Win on insurance risk, not investment risk
The growth of both the insurance-linked securities market and other forms of collateral reinsurance has also meant an increase in the need for collateral requirements. The use of trusts is now outstripping letters of credit (LOCs) but re/insurers remain very conservative in the way they invest the assets in those funds.
That is the perspective of Robert Quinn, vice president and business development leader, Insurance Collateral Solutions, at Wilmington Trust.
Quinn has touted the benefits of trusts in lieu of LOCs and he notes that trust accounts now seem to be the dominant collateral mechanism.
But in terms of the investment of trust funds, he says a trend of “conservative” investing, has ruled trusts funds for years, is continuing.
“I can only tell you what I observe from the over 2,500 trust accounts I have established. Cash and cash equivalents were fairly normal pre-financial crisis. Since the financial crisis, they are dominant,” Quinn says.
“The comment I hear most is that ‘We are taking enough risk on the insurance. We don’t need principal risk on our collateral as well.’ A number of times I have heard words to this effect: ‘I want to be able to sleep at night, so leave it in cash.’
He adds that ILS funds and reinsurers have also been shying away from so-called prime money market funds.
“Everyone does things for their own reasons but the one commonality that I have seen in the reluctance to use prime funds is this: prime funds no longer have the objective of a net asset value (NAV) of one,” he explains.
“This is to say that a $1 deposit into a prime fund might tomorrow be less than $1. With cash you always know what your trust is worth. This variability (or volatility) is what funds and reinsurers try to avoid. Ultimately they want to wake up in the morning and see their trusts fully funded.”
Quinn says that specifically in relation to ILS and collateralized reinsurance, some 85%-90% of the trusts he has established simply reside in cash earning interest. A few use treasuries and a few have investment managers that “carefully navigate the risks of investing”.
He concludes: “In summary, there are investment options. But the objectives of my clients seem to be this: win on the insurance risk, not investment risk.”
