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Investing in Insurance Risk

By Alex Krutov


The rapid growth of the market for insurance-linked securities has highlighted the need for information on the types of these securities and the issues involved in their structuring, pricing, trading, and managing on a portfolio basis.

Publish date: 3 Jun 2010

Availability: In stock

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Book - Investing in Insurance Risk

Book description

Insurance-linked securities and certain reinsurance instruments provide the ability to invest in insurance directly, as opposed to investing in equities or debt issued by insurance and reinsurance companies. The “pure” insurance risk component of these investments can range from that of property catastrophe to longevity, all of which provide limited correlation with the investment performance of traditional asset types.

Securitisation of insurance risk has also become an important tool for risk and capital management that can be utilised by insurance companies alongside the more traditional approaches. It offers insurance and reinsurance companies additional flexibility at a time when the landscape keeps changing and the ability to respond to changes quickly is a critical source of competitive advantage.

Investing in Insurance Risk by Alex Krutov looks at all of the issues involved in investing in insurance risk and insurance securitisation. It examines the various types of insurance-linked securities now available to investors, along with techniques for their analysis. In addition, the book explains the considerations insurance companies face in transferring insurance risk to the capital markets.

The book is somewhat provocatively titled Investing in Insurance Risk to emphasize that investing always involves the potential of both return and risk. This is particularly clear in a field such as insurance-linked securities, where risk transfer?rather than simply raising capital?is often the primary driver for issuing these securities. The ability to analyze the risk-return profile of these investments is essential for both issuing and investing in them.

The book is designed to serve as a valuable resource to those active in the insurance-linked securities marketplace, while also aiding basic understanding of the topics for those new to the field. The author offers a clear practitioner’s perspective as opposed to an academic one; this hands-on approach is particularly important in a market that is new and still evolving.

Book details

Book 9781904339564xy / EBook 9781908823144
Publish date
3 Jun 2010
155mm x 235mm

Author biography

Alex Krutov

Alex Krutov is Managing Director of Century Atlantic Capital Management, where he developed an investment strategy across all types of insurance-linked securities (ILS) and collateralized reinsurance, as well as portfolio optimization and risk management techniques for ILS and reinsurance. Prior to joining the firm, he was President of Navigation Advisors LLC, a New York management-consulting firm focused on the insurance industry, capital markets, and general management. Prior to founding Navigation Advisors, Alex Krutov was employed in a variety of roles, including officer-level positions, at companies such as Transatlantic Reinsurance Company, American International Group, Reliance Group, UBS Warburg, and AXA Financial.

Alex Krutov’s primary expertise and experience involve the products that bridge the gap between (re)insurance and capital markets. He has strong expertise in insurance securitisation, alternative risk transfer, reinsurance and insurance underwriting, portfolio issues in investing in insurance-linked securities, risk analysis, pricing of catastrophe (re)insurance risk, and general management.

Alex Krutov is a member of the American Academy of Actuaries, the Casualty Actuarial Society, and the Society of Actuaries. He chairs the Risk-Based Capital Committee of the American Academy of Actuaries. In addition to his actuarial credentials, Alex Krutov holds an MBA in Management and Finance from the Columbia University Graduate School of Business. He also holds an MS in Physics.

Table of contents


1 Investing in Insurance Risk

Investing in risk

Insurance risk

Insurance markets

Securities issued by insurance companies

Insurance-linked securities

Investing in insurance risk

2 Insurance-Linked Securities

Insurance-linked securities defined

Types of insurance-linked securities

Yield and diversification offered by insurance-linked securities

Market dynamics


3 Property Catastrophe Bonds

Securitisation of property insurance risk

Motivation for transferring natural catastrophe risk to the capital markets

Historical perspective

Risk transfer in insurance

Catastrophe bond structure

Default triggers

Number and types of perils


Quantitative analysis

Investment performance of cat bonds

Market stability and growth

More on the sponsor and investor perspectives

Modelling property catastrophe insurance risk

Cat bonds: trends and expectations

4 Modelling Catastrophe Risk

The challenge of modelling catastrophe events

Importance of catastrophe modelling to investors

Modelling catastrophe insurance risk of insurance-linked securities

The science of catastrophes

Earthquake frequency and severity

Earthquake location

More on earthquake modelling



Historical frequency of hurricanes threatening the US

Seasonality of the hurricane risk in insurance-linked securities

Landfall frequency in peak regions

Hurricane frequency effects over various time horizons

Investor views on macro-scale frequency effects

Evolution of investor views on catastrophe modelling

Elements of hurricane modelling

Damage modelling

Financial loss modelling

Catastrophe model structure

Modelling terrorism risk

Modelling pandemic flu risk

Practical modelling of catastrophe risk

Data quality

Investor and catastrophe modelling

Catastrophe bond remodelling

Hurricane forecasting

Climate change

Sponsor perspective on modelling

Modelling as a source of competitive advantage to investors

Modelling as a source of competitive disadvantage to investors

Trends and expectations

5 Catastrophe Derivatives and ILWs

Index-linked contracts

Role of an index

Catastrophe derivatives defined

Industry loss warranties defined

Market size

Key indexes

Modelling industry losses

The ILW market

ISDA US wind swap confirmation template

IFEX catastrophe derivatives

CME hurricane derivatives

Eurex hurricane futures

More unusual products

Comments on pricing

Credit risk

Basis risk

The use of transformers

Investor universe

Mortality and longevity derivatives

Investor and hedger perspectives

Trends and expectations

6 Reinsurance Sidecars and Securitised Reinsurance

Securitisation of reinsurance

Reinsurance sidecars

Sidecar structure

Investor perspective

Sponsor perspective

Sidecar types

Investor universe

Considerations in investment analysis

Trends and expectations

7 Credit Risk in Catastrophe Bonds and Other ILS

Credit risk

Credit risk and ILS

Traditional solutions

The need for new solutions

Solutions to credit risk issues in insurance-linked securities

Triparty repo arrangement

Customised puttable notes

Use of US Treasury money market funds as collateral

Collateral options in collateralised reinsurance

Trends and expectations

8 Weather Derivatives

The broader definition of insurance-linked securities

Weather derivatives defined

Heating and cooling degree days

Other types of weather derivatives

Payout on standard options

Exchange-traded weather derivatives

Pricing models for weather derivatives

Practical challenges in pricing

Investing in weather derivatives

Emissions trading

Trends and expectations


9 Funding Excess Insurance Reserves

Excess insurance reserves

Some examples

“Excess” reserves

Funding solutions

Embedded-value and value-in-force securitisation

Market fluidity

RBC requirements leading to “unnecessary” capital strain

Regulation XXX reserve funding

Letter-of-credit facility for funding regulation XXX reserves

Securitisation of Regulation XXX reserves

Other solutions

Additional considerations for investors

Funding AXXX reserves

Loss portfolio transfer


10 Embedded-Value Securitisation

Rationale for embedded-value securitisations

Embedded value and value-in-force defined

Direct monetisation versus true securitisation

Closed block

Investor perspective

Specific structures


Stress scenarios

Ratings of EV securitisations

Examples of EV securitisation

Gracechurch/Barclays EV securitisation

Trends and expectations


11 Securitisation of Extreme-Mortality Risk

The risk of extreme mortality

Securitisation of extreme-mortality risk

The groundbreaking Vita securitisation

Other securitisations of extreme-mortality risk

Basis risk

Credit enhancement

Investor types

Extreme-mortality risk quantification and pricing

Current modelling approaches

Mortality derivatives

Additional considerations for investors

Extreme mortality securitisation: trends and expectations

12 Life Insurance Settlements

Insurance policy as a tradable asset

Life settlements

Life settlement securitisations

Legal and ethical issues

Market participants

Current and future market size

Regulatory issues

The link between investor risk and consumer protection

Tax issues

Insurable interest

Investor- or stranger-originated life insurance policies


Trust structures and investor due diligence

The use of not-for-profit organisations in life settlements

Investor perspective

Insurance industry perspective

Risks to insurers


13 Mortality and Longevity Models in Insurance-Linked Securities

Mortality and longevity

Mortality rates

Mortality tables

Population mortality tables

Mortality dynamics

Select and ultimate tables

Credibility theory approach

Longevity improvements

Lee–Carter and related methods

Markov process of mortality and morbidity

Direct age transform mortality modelling

Mortality and longevity shocks


14 Valuation of Life Settlements and Other Mortality-Linked Securities

Modelling investment performance of life settlements

Life expectancy

Methodology changes in the calculation of life expectancy

Underwriting concepts


Choice of mortality table

2008 valuation basic table

Relative risk ratios

Underwriting for older ages

Choosing the LE

LE shopping

Assumed premiums

Being paid for the risk


15 Longevity Risk Transfer and Longevity-Linked Securities

Longevity risk

Need to transfer longevity risk

Longevity improvements

Natural hedges

Primary mechanisms of longevity risk transfer

Longevity swaps

Mortality forwards and survivor forwards

Longevity bonds

More on other solutions for longevity risk management in a DB pension fund

Indexes of longevity

Investors in longevity

Market developments

Extension risk in traded policies

Trends and expectations


16 Managing Portfolios of Catastrophe Risk

Portfolio construction

Exotic beta

How catastrophe risk is different

Measures of return and risk

Managing a portfolio of cat risk by a (re)insurance company

Managing a portfolio of catastrophe insurance-linked securities

Types of instrument

Portfolio constraints

Standard tools and the modelling of individual securities

Portfolio optimisation

Pitfalls of standard optimisation techniques

Remodelling and portfolio optimisation

Sensitivity analysis and scenario testing

Additional considerations

Performance measurement


17 Managing Portfolios of Multiple Types of ILS

Types of insurance-linked securities

Rationale for combining different types of ILS in the same portfolio

Correlation among different types of ILS

Tenor and liquidity

Portfolio optimisation

The argument against combining ILS of multiple types in the same portfolio

Portfolio valuation issues

Performance measurement

Investment management policy

Risk management


18 Conclusion

Customer Reviews

Average customer reviews for Investing in Insurance Risk

Advanced risk analysis for seasoned practitioners and beginners

It's the best book on insurance risk and insurance-linked securities that I've seen. It's clear and logical.

More than half the book is about risk analysis and modeling. Catastrophe theory plays a big part in the modeling described by Alex Krutov. The models cover catastrophic events hurricane, earthquake, flood, terrorism, man-made disasters other than acts of terror, pandemic diseases, mortality and longevity, and other black swan rare events. The similarity of modeling approaches is striking. These events involve many parts moving in uncertain ways that are difficult to predict. The uncertainty exists even where the data available is voluminous. Simplified versions of the models are used by FEMA for disaster preparation. Other models can be extended to financial shocks and cyber terrorism. Most of the same models can be used in modeling events that do not reach catastrophic levels.

Some chapters are too difficult for readers without deep knowledge of statistics and could be skipped. Formulas are avoided except for the few chapters that have too many of them. Chapters with too many formulas are closer to the end of the book. Using simulation in non-linear constrained optimization is done for modeling risk aggregation. Evolutionary and other artificial intelligence algorithms are proposed for portfolio optimization and risk management.

Most chapters are easily understandable and don't assume prior knowledge of the subject. They don't require statistical and actuarial knowledge. Catastrophe bond chapters don't assume knowledge of catastrophe bonds. Modeling of catastrophic risk embedded in catastrophe bonds is in other chapters.
Review by Marin Q , 07/07/2014

Authoritative Guide to the World of Insurance Risk \ Recommended

The book is an authoritative guide to the world of insurance risk. It is the most useful, comprehensive and internally consistent of the currently available sources of information on the topic.

Its title creates the impression that the view of investors is presented. While true, the author takes an interesting position that insurance and reinsurance companies are themselves investors in insurance risk and also presents their view.

There is an attempt to start every topic by explaining the fundamentals and introducing new concepts. At times the author fails at patiently explaining the basics and quickly jumps to the more advanced material. Some topics require prior knowledge of the concepts not explained in the book. Overall the approach is consistent and makes reading the book easier.

Few readers will be interested in all the topics covered in the book. Most will read the chapters of interest and then keep the book on a shelf for future reference.

It is not a textbook. While it can be used for this purpose, some of the material is too advanced and specialized for a class. Those already working in this or an adjacent field will find the book most helpful. It is highly recommended.

The quote below is taken from the review published by The Actuary in the UK.
Charlie Munger, Warren Buffet's partner at Berkshire Hathaway, once summed up the properties of true wisdom in the following way:

"What is elementary, worldly wisdom? Well, the first rule is that you can't really know anything if you just remember isolated facts and try and bang `em back. If the facts don't hang together on a latticework of theory, you don't have them in a usable form."

Alex Krutov has constructed just such a latticework of theory in his book Investing in Insurance Risk -- Insurance-linked Securities, a Practitioner's Perspective. Though the title points to the end goal, this is a self-contained primer leading from the foundations of the principles of insurance all the way to the reasons insurance-linked securities (ILSs) should be a staple of all serious investors' portfolios.

While this is probably obvious for most insurance professionals reading this review, the book has more to offer than this conclusion. It is well worth reading for the deep examination of long-held assumptions, some of which seem less valid under his logical scrutiny. The book is broadly focused; it examines property catastrophe risk transfer to the ILS market (probably best known in the form of 'cat bonds'), as well as other less well-known types of risk that are transferred as tradable securities, such as weather derivatives, excess insurance reserves, embedded value, mortality and longevity risk.

As you would anticipate of a book that gives you the facts from a practitioner's perspective satisfying Munger's mantra, Krutov deftly builds the case for investing in ILSs by slowly constructing the intellectual edifice required to ensure the reader is well informed in the important areas of consideration.

Crucial topics for any investor, such as the determination of potential loss or credit risk considerations, are addressed pragmatically. The important aspects that investors should consider when assessing individual issuances are highlighted, as well as the main consideration necessary when building a portfolio of these investments.
Review by Ultimi Terremoti , 07/07/2014

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