[HN Gopher] How insurance risk is transformed into investable as...
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How insurance risk is transformed into investable assets
Author : rrjjww
Score : 135 points
Date : 2025-09-26 20:46 UTC (1 days ago)
(HTM) web link (riskvest.io)
(TXT) w3m dump (riskvest.io)
| blakepelton wrote:
| I've asked two financial advisors about CAT bonds. One had never
| heard of them and the other said were about as risky as crypto. I
| guess this is such a niche product that there isn't widespread
| knowledge about it.
|
| I wonder how much more diversified $ILS could be if it were
| larger. Would a 10x increase in assets under management give it
| significantly less volatility because it could do a better job
| spreading risk around the globe?
| rrjjww wrote:
| The lack of information was my inspiration for building
| Riskvest. I called my own broker and when I said catastrophic
| bonds they asked if I meant buying bonds already in default.
|
| On the risk side - your comments here are part of the myth I'm
| trying to dispel and will have lots more to say in future
| posts.
|
| Yes for a single CAT bond you are exposed to potential 100%
| principle losses. But if you buy a bundle of CAT bonds that
| focus on say California Earthquake, Florida Hurricane, Japanese
| Typhoon, and a Cyber Event, you can imagine the diversification
| benefit you get there.
|
| I've already created a very very simple model for people to
| play around with and learn the intuition for CAT bond return
| patterns. A default means 100% loss and this is unique vs.
| other bonds. I plan in the future to build a much more robust
| model.
|
| https://www.riskvest.io/data-lab/cat-bond-portfolio-simulato...
| bawolff wrote:
| > But if you buy a bundle of CAT bonds that focus on say
| California Earthquake, Florida Hurricane, Japanese Typhoon,
| and a Cyber Event, you can imagine the diversification
| benefit you get there.
|
| Yeah, but imagine how bad a day you're having if all of those
| disasters happen at once, and then as a cherry on top you
| lose all your money.
| itake wrote:
| Yeah, it seems like you'd want to buy bonds that covers
| areas that you're not personally in...
| richardfey wrote:
| Why? It's not like you can influence the trigger of any
| such catastrophe
| pm215 wrote:
| Same principle as why many people prefer not to own
| shares in the company that employs them -- you're already
| heavily exposed to that specific risk and don't want to
| add more. If you live in Florida then a hurricane in
| Florida already might mean financial loss for you if it
| damages your house, so buying a CAT bond that covers a
| different thing is more diversified risk: you might get
| "house is trashed" or "bond is total loss" but at least
| you probably will not get both at once.
| olooney wrote:
| CAT bonds are typically restricted to institutional investors.
| I would be very surprised if you could even buy one without
| being a QIB.
| rrjjww wrote:
| New opportunities for retail investors have been popping up
| lately! That's a big part of what Riskvest is meant to
| document.
| anjel wrote:
| https://riskvest.io/market-watch/ils-nyse-offering
| bvan wrote:
| It has been growing slowly for the past 25 years. The limited
| market size is a reflection of the demand by traditional
| insurers and reinsurers, for alternative sources of capital.
| This is as it should be.. when traditional players start
| transferring risk to the capital markets motivated by the fees
| involved, or cheaper rates (premium), then you really start
| worrying about moral hazard i.e. 'bad risks' getting
| transferred to investors.
| jbs789 wrote:
| There are institutional funds but generally it's a small market
| with very limited retail presence. Schroders has one. (Artemis
| is a great source of info in the space - niche trade
| publication.)
|
| https://www.artemis.bm/ils-fund-managers/schroder-investment...
| antasvara wrote:
| There are a lot of interesting dynamics in this market.
|
| For example, CAT bonds are generally tied to the specific natural
| hazard ("this bond triggers if a hurricane of Category 3 or
| higher land falls in this segment of Florida") or to industry
| losses, as estimated by an agreed upon source.
|
| This means that a CAT bond is correlated with, but not directly
| informed by an insurer's actual loss experience. Traditional
| reinsurance (so an insurer themselves getting insurance) will
| usually be tied to specific policies, so their experienced loss
| is what determines payout.
|
| However, depending on the insurer's policies, traditional
| reinsurance may be unavailable or much too expensive (either due
| to the large limit needed, the risk level of the policies, or any
| number of other reasons). Depending on the trigger, a CAT bond
| can also pay out faster because you don't have to wait to see the
| claims from 100k home insurance policies.
|
| From the technical side, most large reinsurers license CAT
| modeling software from one or both of the same two vendors:
| Moody's RMS or Verisk. The biggest reinsurers will develop their
| own models, and there are other modeling vendors that they may
| license for particular perils (EQEcat for earthquake and KatRisk
| for flood come to mind), but the big two are pretty widely
| accepted in reinsurance markets.
|
| That means if your policies are "odd" in some way (uncommon
| construction type, power facility, etc.), depending on how a
| reinsurers chooses to model them (or how the model specifically
| handles them) can have a big impact on your reinsurance pricing.
| If you know something about your policies that can't be
| incorporated into a vendor model very well, you may get better
| pricing on a CAT bond.
|
| These are just some of the considerations! There are so many more
| things that go into it. But I think it's super interesting to
| think about.
|
| Source: I work in this side of the industry, specifically in
| natural catastrophe modeling.
| rrjjww wrote:
| Correct on every point and great insight, hello fellow
| insurance person.
|
| I will clarify that CAT bonds can have industry loss triggers
| OR actual indemnity triggers. If an indemnity trigger then the
| insurer has to prove the actual loss. But you're right on ILWs
| (Industry Loss Warranty) in that there is additional
| model/basis risk considerations.
|
| Insurance companies try to minimize this basis risk. Because
| while sure it's great to be in the situation where your CAT
| bond recovers when you didn't have large losses, it's NOT good
| to be in the position where you had big losses and you don't
| recover. Certainty of recover can affect things like how much
| regulatory credit you get for your reinsurance.
| rogerrogerr wrote:
| Curious what major trends you're seeing in your line of work.
| Guessing global warming induced increase in weather related
| hazards in some places - anything that would be surprising to
| people outside the industry?
| NoboruWataya wrote:
| > CAT bonds are generally tied to the specific natural hazard
| ("this bond triggers if a hurricane of Category 3 or higher
| land falls in this segment of Florida") or to industry losses,
| as estimated by an agreed upon source.
|
| A big part of the reason for this is that if payout is tied to
| actual loss, it starts to look a lot like actual insurance,
| which is specifically not what you want. Because while anyone*
| can buy a bond, only insurers or reinsurers can write
| insurance. This is something that needs to be considered
| whenever an insurer (or anyone, really) tries to transfer risk
| to a non-insurer.
| Zenst wrote:
| Having worked on reinsurance software in the 90s, one question
| that springs to mind, which came to light from the asbestos
| claims era, was brokers commission. What did happen was brokers
| would package up risks and sell those off (taking commission)
| which would see other brokers bundle those up and again package
| them and others up into a bundle and sell those off. So when a
| claim came down the line, that was huge, like the asbestos
| claim in period
| https://en.wikipedia.org/wiki/Lloyd%27s_of_London which saw
| such a diluted risk and brokers commission leaching all profit,
| brought many down financially due to exposure.
|
| So interested how things are today regarding brokers endlessly
| packaging up risks they sell on, rinse repeat. I'm aware of
| certain changes that came about to reinsurance brokers in both
| the Lloyds and London Markets on the back of the asbestos claim
| era, but not sure of the the CAT model risks/insurance
| regarding brokers endlessly packaging up to offset risk
| exposure vs regulations limiting how much they can do that -
| more so the USA market.
|
| So curious - is there a risk from brokers diluting risks for
| commission profits in this market or is that saftly covered
| against and regulated?
| rrjjww wrote:
| Blown away by the traffic from this post!
|
| For the web designers here please let me know if you noticed
| anything amiss. Ive had particular issues getting captchas
| working so please comment if you run into that issue.
| bradly wrote:
| > For the web designers here please let me know if you noticed
| anything amiss.
|
| The images some of the visuals do not show in reader view in
| Safari and Firefox. Other than that, the content is well laid
| out and very readable.
| trevithick wrote:
| Very minor nit: "It's clear that we this structure,..."
|
| Cool article, it's a clear explanation of something I never
| knew about.
| rkagerer wrote:
| Thanks for sharing your insight. Wouldn't hurt from a
| proofread. There are some typos / wrong words, that detract
| from the sense of authority lent by the article. Eg:
|
| _" It's clear that we this structure"_ --> with
|
| _" with out those protections in place"_ --> without
|
| _" Investors would be best to limit their exposer to losses
| beyond their investment"_ --> exposure
|
| There might have been others, I had to go back and skim to
| summarize for you.
| rrjjww wrote:
| Thank you! No matter how many times I read things over I
| managed to leave a few behind. I will make those edits
| shortly.
| OgsyedIE wrote:
| Would you consider a followup post about reinsurance assets
| targeted to derisk potential systemic or liquidity risks in the
| entire CAT bond market?
| rrjjww wrote:
| I'm not aware that these currently exist but the concept of
| reinsurance on reinsurance is not new (it's called
| retrocession). I will do some digging and see what I can find -
| thanks for the suggestion.
| rubyfan wrote:
| Great site, very well written and great explanations of insurance
| industry dynamics.
| cosmic_quanta wrote:
| What a wonderful read! This is why I come to HN: technical, yet
| approachable, discussions on topics I didn't even know existed.
| Thank you for sharing!
| Mistletoe wrote:
| This feels like when Selena Gomez explained CDOs in The Big
| Short.
| fragmede wrote:
| (Margot Robbie)
| WrongAssumption wrote:
| Different scene. Margo Robbie explained sub-prime mortgages.
| Selena Gomez explained synthetic CDOs.
| fragmede wrote:
| TIL, thank you!
| nenenejej wrote:
| This topic feels closely related to GFC.
| nilirl wrote:
| So, did the Covid 19 pandemic force multiple insurance companies
| into insolvency?
|
| Also, what does new product development look like for industries
| like this? How does one search for new financial products? Is it
| possible for a non-expert to come up with new products in this
| space?
|
| Are there any books you can recommend for a novice?
| quantum2022 wrote:
| I don't think so. I'm pretty sure it was considered an 'act of
| G-d', not an act of China :)
|
| I think you could also have specific pandemic insurance, and
| that paid out, but those were rare before Covid.
| dan-robertson wrote:
| Why would it? I don't think that much pandemic insurance is
| written and obviously you model all the contracts as being very
| highly correlated.
| ascorbic wrote:
| In the end there's always someone left holding the can. Lloyd's
| of London has underwriters with unlimited liability.
| Incredibly, a lot of these Names have historically been private
| individuals. In the 90s a lot of these lost their shirts (and
| their homes) when they dicovered that it wasn;t just an easy
| source of passive income.
| https://www.theguardian.com/money/2000/nov/04/business.perso...
| jbs789 wrote:
| The impact was nuanced, and depended on the specific policies
| in place.
|
| Some businesses had business interruption insurance which paid
| out. Many policies exclude highly correlated events such as
| pandemics.
|
| And then think about specific events which were cancelled,
| which may have bought policies protecting them if cancelled.
|
| And of course life insurance and health care would have been
| affected.
|
| SwissRe often produces public reports in the space if of
| interest:
|
| https://www.swissre.com/risk-knowledge/building-societal-res...
| rrjjww wrote:
| While Covid 19 was certainly a "Catastrophe", the market for
| pandemic insurance in 2020 was minuscule and to my knowledge
| did not cause any insurer solvency issues. There were a few
| cases of insurers being instructed to pay out significant
| claims by the courts on Business Interruption losses which the
| insurers argued were not covered due to existing policy
| exclusion.
|
| Product development is usually highly specialized as there are
| a lot of nuances and frictions within the insurance industry
| that outsiders may not fully understand. It helps also to be in
| the industry and have the network with insurers, reinsurers,
| brokers, etc. This is not at all to suggest there isn't room
| for clever people to bring innovation to the market though!
|
| Book recs are hard to specify for CAT bonds but for insurance
| in general:
|
| Against the Gods: The Remarkable Story of Risk - Peter L.
| Bernstein
|
| The Black Swan - Nassim Nicholas Taleb
|
| On the Brink: How a Crisis Transformed Lloyd's of London -
| Andrew Duguid
|
| The last one is a personal favourite of mine
| quantdev1 wrote:
| Big fan of your content design :)
| rrjjww wrote:
| Thank you! As an Actuary I'm not exactly known for my design
| skills so it was a lot of effort to get things looking the way
| I wanted.
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