Investment gains can be made on trusts

As re/insurers head into negotiations in Baden-Baden this year, thanks to the growth of alternative risk structures, more than ever they will also be debating the best way of managing and structuring collateral requirements needed on certain types of deals.

Robert Quinn, vice president and business development leader, Insurance Collateral Solutions, at Wilmington Trust, says that the landscape is changing in this regard—but some insurers are not making the most of the techniques available.

The growth of the insurance-linked securities (ILS) 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, he points out.

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 trust funds for years, and is continuing.

“I can only tell you what I observe from the more than 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 ‘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

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 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 1,” 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 collateralised reinsurance, some 85 to 90 percent of the trusts he has established simply reside in cash earning interest. A few use treasuries and a few have investment managers who “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.”