This paper firstly provides a description of the development of securitization in insurance industry. It also introduce the details of securitization process. Meanwhile, the paper displays the reason for the demand of securitization by description of experience in insurance industry. Then it shows how the securitization is applied in insurance industry. What's more, the paper includes the comparison between reinsurance and securitization from three aspects. Finally, it conclude the advantages of securitization.
Securitization is one of the most important innovations in financial market. Compared with insurance and reinsurance, securitization always stands ...view middle of the document...
Therefore, since 2007, insurance and reinsurance corporations started to use securitization as a compensation of unexpected disasters for hedging risk even though the loss ratio was not that high at that time.
Overview of Securitization Process
Securitization is the process by which an asset or asset pool is repackaged and sold for cash in capital market.The cash is raised by the issue of securities whose cash flows are collateralized by the principal and interest income on the original asset. Even though asset-backed securities (ABS) have been issued derived from different types of cash flows and different kinds of securities, the structure of those ABS transactions are almost similar.
There are several important elements that are involved in insurance-linked transactions. It starts with an originator who initiates the contracts giving rise to the cash flows that are finally securitized. Originators usually are banks and institutions who own sensitive asset, such as residential and commercial mortgages and other types of loans, insurance policies and annuities of life insurance companies, and various types of financing agreements of industrial firms. The originators provide products to their clients, who will pay a series of payments in the future period. The present value of those principal and interest payments will constitutes an asset of the originator. Generally, the originator records the asset earned from the transaction of the products on its balance sheet. The asset-backed securities market gives the originator a way to move the asset off balance sheet by securitization. The asset is usually moved off by transferring the asset to a special purpose vehicle (SPV), a financial entity who exists independently to deal with the asset and issue securities with the asset as collateral. Then, the special purpose vehicle issues securities to investors who provide capital to the SPV. (Cowley, 2005)
Drivers of Demand for Securitization in insurance industry
First of the primary factor is catastrophe experience. After suffer from significant catastrophe losses, the possible maximum losses was estimated that could be more than ten billion dollars. The demand and pricing of reinsurance increase significantly. Meanwhile, the availability and stability of reinsurance could be a problem because of the huge losses. After diversification and reinsurance, the insurer and reinsurer still face the problem of undiversified risk, which can lead to unexpectedly high losses. Under the circumstance, the crash to the insurance industry could be handled efficiently by the capital markets.
Secondly, more and more investors get involved into capital markets because of its rapid development . At the same time, new asset classes and asset-backed market are in demand. From investment perspective, uncorrelated asset is always used for diversification.
Thirdly, the changing of structure of the insurance industry, such as mergers and acquisitions, illustrated that...