Negative rates & systemic risks in re/insurance, a potential solution

According to U.S. insurance broker Joann Koziol, the insurance and reinsurance industry faces two primary problems. One is systemic risk and the other is NIRP (Negative Interest Rate Policy).

Systemic risk is greater concentrations of risks within smaller time spans, while NIRP impacts returns on reserves and premium income.

A new and original product being developed by Koziol, of ASZ International, and a team of insurance professionals and economists hopes to provide insureds and insurers with the means to protect assets, liabilities, and reserves from both.

Negative rates have a cannibalising effect on insurance and reinsurance industry returns. For example, many developed markets are essentially experiencing negative coupons, or “destruction of invested capital” as Koziol describes it.

Some banks have applied negative rates to accounts. Others are considering doing the same. Simply said, depositors, lenders and savers will receive less than what they have invested. Basically investors/savers are paying borrowers to lend the borrowers funds.

Koziol described the NIRP effect as “analogous to insurance companies providing coverage whereby the insurer pays the insured to buy coverage.” It is her belief, that this alone could cripple the industry in only a matter of time.

Now imagine if this were to occur in tandem with a few major catastrophic events. In today’s market, carriers are regularly signing up more and more insureds, at reduced premiums, which is problematic as risks can be correlating and underlying assets/reserves are shrinking. The likelihood of a carrier unable to pay claims in the event of a disaster is increasing over time.

For Koziol, this trend is a focus, and along with a team of insurance and reinsurance experts, economists and risk managers, she is creating a solution in the form of a new framework for insurance transactions.

Reinsurance is a derivative (first, second, n, etc) of insurance.

“It is irrelevant whether reinsurers are the first or n derivative, they are moving towards systemicity,” Koziol said. If underlying insurers or derivative reinsurers fail, then what?

“With negative rates spreading across developed markets, this impairs the system’s ability to generate positive returns,” Koziol continued.

This is a systemic driver – a guarantee to lose money, in Koziol’s opinion, needing a solution that not only helps re/insurers make more money, but also more safely.

Comparatively speaking, Koziol explained “in a NIRPy world where savers pay borrowers interest, why not have insurers pay insureds to increase coverage? This space has a huge potential impact for reinsurance companies as many hold European and/or Japanese bonds a number of which have negative yields.

“What is needed is a solution that creates new revenue streams, fully diversifies portfolios and delivers products consumers want and need. This is what we are working on – solving Markowitz’s portfolio theory issues.”

In Koziol’s view, “The best way to survive today’s soft, turmoil and overexposed market is through innovative alternatives.”

Joann and her team of economists, hedging experts and insurance professionals are working to create solutions through various hedging techniques, instruments and patented methods.

They claim to have created new and improved risk transfer solutions and, what they term, “an overall heterogeneous insurance space.”

Their aim is to create products and solutions that will provide those in capital markets, as well as traditional insurance and reinsurance carriers, with completely new insurance or hedging products, as well as new tools for the transfer of risk, resulting in new opportunities to assume those risks as well.

“These insurable properties may be on the land, below the land, above the land, or exist virtually or synthetically, all without limitation,” Koziol explained.

Now that sounds intriguing, as insuring “properties” can perhaps be translated to “assets” in this case, which suggests Koziol and her team are creating risk transfer processes which can be applied across a wide range of assets potentially creating ways to insure the previously uninsurable.

With a hedging focus, there is of course the potential for asset related risks to be structured, securitised and become capital market tools. Which is tantalising in terms of potential for growing the insurance and reinsurance pie, with a leading role for capital market practices and investors.

We asked Koziol for further details on the methodology and she explained that it involves US Patent # 8,566,128.

The patented solution manages health and wealth, isolated or catastrophic, interactions between underlying or initial risks, derivatives and securitizations. There are other patents pending and various other intellectual properties.

It’s a fascinating product development with applications in insurance, reinsurance, risk hedging and risk transfer, with both the traditional re/insurance markets and the capital markets likely to have appetite to understand more.