Insurance giant Zurich is considering leveraging the capital markets and ILS investors as a way to offload more bank related operational risk, in similar arrangements to the recently completed Operational Re Ltd. deal for investment bank Credit Suisse.
According to a report from Bloomberg, Zurich is looking to the issuance of catastrophe bonds and capital market investors as backing for selling further operational risk insurance policies to large banks.
With operational risks, such as rogue trading, cyber risk, system failure, fraudulent behaviour both of external parties and employees of the investment bank, fiduciary issues, losses due to improper business practices or unauthorised activity, accounting errors, documentation errors, regulatory compliance issues, HR issues, discrimination in the workplace or even personal injury, a key concern for banks, selling an insurance product to them could be a valuable new line for Zurich.
When the Credit Suisse sponsored Operational Re transaction came to market, the deal documentation stated that the reason the capital markets were to be tapped with the cat bond like issuance was that the traditional reinsurance market could not provide the capacity to enable Zurich to offer the insurance policy.
Zurich would not want to retain too much of each transaction, in the case of Operational Re it appears Zurich retained just CHF50m of the CHF270m insurance policy, with the Operational Re cat bonds sold to capital market investors supplying the other CHF220m of protection.
Hence for Zurich to offer this insurance policy to other banks it needs to ensure a pipeline to the capital markets is open, enabling it to securitise the majority of each bank operational risk insurance policy it provides, with the capital markets and ILS investors buying the resulting notes.
For the ILS markets and other capital market, fixed income type investors, a regular pipeline of operational risk linked bonds would be an attractive proposition. It could help to broaden the ILS market into a new peril, albeit one which is clearly correlated to a degree with broader financial markets, meaning it will not suit every ILS investor mandate.
With ILS often sold to end-investors on the benefits of low correlation with the whims of financial markets, investing in bank related risk may be too diluting of this benefit for many ILS managers and funds.
But for every ILS fund manager or investor who would not want to assume bank-related operational risk, there will be others who would love to get their hands on more issuance of this kind.
Bloomberg’s article quotes a Zurich spokesperson as saying “We are now exploring the possibility of offering similar solutions for other banks,” and explaining that these are tailored products and not something that can be easily created “off the shelf.”
Given the successful issuance of the Operational Re Ltd. operational risk cat bond or ILS, albeit at a significantly reduced size from the CHF630m originally sought for Credit Suisse, it’s clear that the capital markets have some appetite for such operational risk bonds.
Zurich could carve itself out a niche and unique insurance product, with the assistance of the capital markets and ILS capacity, something that could result in a profitable line given the pressure on banks to shore up capital and reduce risk.
So, with the initial Operational Re issuance completed it’s no surprise that Zurich would look to emulate the transaction. If insurance-linked investors can help it to create a new business line then that is a positive thing and a demonstration of another way traditional incumbents can leverage the convergence and ILS trend to help create new products.
If a risk is too big for traditional re/insurance markets then maybe sharing it with capital market investors can provide the reinsurance capital necessary to make selling the insurance product viable. For under pressure traditional players this could prove an attractive way to partner with ILS and third-party capital.