inea GmbH, a German firm that structures and offer investment opportunities including insurance-linked securities (ILS), has completed a new lottery winning risk collateralized reinsurance transaction, which has become the first ILS deal to be domiciled in Gibraltar.
inea GmbH has named the collateralized reinsurance deal the Fortuna Transaction. It’s the firm’s second ILS deal to cover lottery winning risks, after it brought the first of these types of transaction to market in 2011 with the Hoplon Insurance Ltd. transaction, which combined securities with collateralized reinsurance.
The Fortuna Transaction, which was completed recently, is a pure collateralized reinsurance transaction. inea GmbH structured the deal for a new client, sponsoring cedent the Lottoland Group, a young but fast-growing Gibraltar licensed online lottery provider, to provide it with a source of re/insurance protection.
The collateralized reinsurance transaction that inea structured for Lottoland provides €100m of annual coverage, including reinstatements. The transaction has been cleverly structured into four distinct layers, with differing levels of winnings required to cause attachment of each.
The four layers benefit both the sponsor and also, perhaps more importantly, the investors. Dr. Norbert Kranz of inea told Artemis that the four layers were designed to suit investors needs, enabling the transaction to be syndicated more broadly.
The layered approach allows the transaction to cover an expected loss range within the reinsurance programme from 2.5% up to a much riskier 12.5%. Split into four layers, that provides different levels of risk and return to suit ILS and capital market investors risk appetites, with different attachment probabilities and rate-on-line for each layer.
The transaction utilises an indemnity trigger, so is based on the actual lottery winnings that Lottoland has to pay out. The deal covers six specific lottery games at launch, providing protection both for so-called ‘winning class 1’ which denotes jackpot wins, and also ‘winning class 2’ which are smaller winnings, but there are more of them so they have a higher probability of occurring.
This effectively provides Lottoland with both protection for large jackpot winnings, as well as cover for losses due to some of the smaller prizes in the lotteries.
The fact that the transaction provides cover for six lotteries means that the deal provides greater diversification within the transaction risk pool for the investors.
The deal is similar to the Hoplon transaction for MyLotto, as; “The transaction uses collateralized reinsurance as we feel this, for the company, is a very flexible tool. Maybe in future the company might also decide to use some bonds, so a mixture of collateralized reinsurance and bonds like Hoplon, but for the time being we feel collateralized reinsurance is more flexible,” explained Dr. Kranz.
There are differences in the transaction as well, including greater flexibility that will benefit both the sponsor and also the investors, Tore Ellingsen, partner at inea GmbH, said.
The Hoplon transaction provided aggregated cover across all the lottery draws during the transaction term, but for this Fortuna transaction the cover is per-draw, meaning that a minimum premium is paid upfront and then add-on premiums top it up.
The add-on premiums paid by the sponsor will depend on the number of draws and the number of entries per draw, across all six of the covered lottery games.
This benefits the sponsor as it is more flexible and ensures they are covered for every draw. It also means an additional draw or perhaps even lottery could be added during the transaction term.
For the investors this helps to reduce basis risk, as they are being compensated for any increase in draws or player entries in each draw. “Investors will always be paid in accordance with the actual volume of lottery plays, so they are paid for the actual risk they are taking,” continued Ellingsen. “We feel this is very fair for both sides.”
The Lottoland ILS transaction has a two-year term and offers investors access to a rate-on-line (ROL) that begins at around 5% for the bottom of the lower risk layer and exceeds 15% at the upper end.
The structure therefore offers an attractive return to investors across a range of risk appetites. As a result of this the ILS deal was fully subscribed by institutional investors, including a number of the world’s largest ILS funds.
The risk modelling for the Fortuna transaction was undertaken by Milliman Inc., the same firm that undertook modelling and analysis for the Hoplon transactions as well.
Ellingsen commented; “We try to get as accurate as possible with the modelling and this, combined with the per-draw cover, provides the most flexible solution to the sponsor, while the risk premium is matched to the risks the investors are taking on, meaning basis risk is limited.”
In terms of the domicile selected for this collateralized reinsurance transaction, this is the first ILS deal to be completed in Gibraltar. Gibraltar has been targeting the ILS space, having prepared its regulatory environment in order to make the domicile attractive for ILS. The Fortuna lottery risk deal is the first to bring a real ILS transaction to the domicile.
The transaction was completed under Gibraltar’s PCC (protected cell company) legislation. The PCC company used for this deal was arranged by Euroguard Insurance Company PCC Limited. Euroguard has been working in Gibraltar as a PCC company for more than a decade and is part of South African financial services group MMI Holdings Ltd.
Nigel Birrell, Managing Director of Lottoland, expressed his pleasure at the deal’s completion, saying; “Our €100m ILS is a cost-effective way to reinsure against wins by our customers who can bet on an exciting range of mega-jackpot lotteries from around the world. Gibraltar has not only set the standards for robust online gaming legislation in Europe, it is now primed to take the lead in the fledgling European ILS market through a progressive approach to financial services.”
Fabian Picardo, the Chief Minister of Gibraltar, commented on the first ILS transactions to launch from the domicile; “The traditional ILS market in the US runs into billions of dollars a year and our sights are set firmly on making Gibraltar the first choice for ILS transactions within the European Union. Given the depressed outlook for interest rates, we believe that Lottoland’s pioneering use of our new legal and regulatory framework for ILS transactions will generate further interest from sponsors and investors in Europe.”
Albert Isola MP, Minister for Financial Services for the Government of Gibraltar, also said; “I am delighted that Gibraltar has completed its first ILS transaction in record time just over a year after setting out our plans for insurance linked securities in Gibraltar. Mike Ashton and the team at Gibraltar Finance have worked extremely hard to make this happen and I am pleased that our efforts in this new area of business are paying off.
“It is particularly gratifying that this transaction involves businesses from both of Gibraltar’s vibrant and growing insurance and gaming sectors. These are important sectors in our community providing valuable employment and other opportunities for our economy.
“Our ILS journey has been swift and has been helped enormously by the formation of the ILS Working Group with Mr. Andre Perez last year in which a number of the largest ILS players participated.
“Finally, I would like to thank both Lottoland and inea GmbH for choosing to structure the transaction here and for their confidence in Gibraltar as the place to break new ground for the ILS sector within the European Union.”
This novel collateralized reinsurance transaction shows how ILS can be used to provide protection for niche risks, how the capital markets and ILS investors can be the capacity providers and that Gibraltar is truly open for ILS business now.
inea GmbH has structured an effective way for Lottoland to financially protect itself against large lottery winnings in the games it manages, showing that the firm continues to provide innovative structuring services to companies looking to tap ILS or collateralized reinsurance as a form of corporate insurance protection.
The innovative transaction also helps to bring new classes of risk into the insurance-linked investments universe, something that is much needed by investors as they seek to diversify away from peak catastrophe risks.