Imagine there’s a way for institutional investors to trade insurance risks much like they trade stocks. Well, imagine no more. A new and unique reinsurer, Extraordinary Re, has hit upon the novel idea of creating a trading platform run by Nasdaq for investors to trade assets tied to insurance liabilities.
The Extraordinary Re platform, which will be launched this year, offers the opportunity for investors to diversify their portfolios outside traditional stocks and fixed-income assets with a new investment class that does not correlate with the risks of other investments. For insurers and reinsurers, the platform presents an innovative way to access the capital markets to buy reinsurance capacity to absorb a wide range of risks.
If this sounds like insurance-linked securities (ILS) or catastrophe bonds, it should. But there’s a difference between such financial instruments that are bought by insurers and reinsurers on a one-off basis and what Extraordinary Re has in mind.
First of all, the company’s trading platform would comprise property and casualty risks beyond property catastrophe, such as terrorism, aviation, marine, workers compensation and product liability exposures. Even life and health insurance risks are on the menu. That alone is disruptive.
But where Extraordinary Re shatters paradigms is the idea of creating a trading platform composed of these diverse perils, in which an investor can sell an interest in a Florida hurricane risk to invest in a business interruption exposure or the mortality risks of people in their 60s.
“We’re building the world’s first liquid marketplace for a wide range of insurance and reinsurance risks,” said Will Dove, Bermuda-based Extraordinary Re’s chairman and CEO. “Hedge funds, pension funds, sovereign funds and other large investors interested in balancing or readjusting their investment portfolios with short-tail, long-tail and even life insurance risks will soon be able to do that.”
Dove, an insurance industry and capital markets’ veteran, projects that the platform will unlock more than $20 trillion of existing liabilities held on insurance company balance sheets while enabling institutional investors to access an attractive return from an uncorrelated asset class. “We see it as a 21st century version of Lloyd’s of London,” he said.
The comparison is apt. Like Lloyd’s, Extraordinary Re offers a marketplace in which people can examine different risks to determine their interest in absorbing some or all of the exposure. At Lloyd’s, these people work for insurers and reinsurers, while at Extraordinary Re, they’re investors. In both cases, if there is a loss, the insurers/reinsurers or investors pay up. If there’s no loss, they come out ahead.
This is a simplification of very complex transactions, of course. But it points to the innovations under way today that could disrupt the historic functions of the insurance industry.
“We’re rethinking how risks are transferred,” said Dove. “There is no particular reason why a single [insurance or reinsurance] company must be responsible for underwriting, marketing, distribution and service to provide all the capital for a risk. A distributed value chain, on the other hand, will result in more flexible availability of capital, reducing overall expenses that lower the cost of products for consumers.”
This value chain is Extraordinary Re’s digital underwriting platform, which offers new ways to connect risks with capital. When the company is up and running—by the end of the year, if not earlier, Dove said—an insurer, reinsurer or broker would present a typical submission for risk capacity, much like the current process. Once received, Extraordinary Re’s underwriters will prequalify the submission to ensure it is a class of risk its platform can support. Assuming this is the case, the submissions are posted electronically.
Investors now come into the picture, reviewing the submission to determine if it fits their portfolio diversification objectives. This is somewhat similar to how the Lloyd’s market operates—brokers calling on insurance syndicates to determine their interest in a submission. “The difference with our platform is that it happens electronically and much more quickly,” said Dove.
Of course, that’s not the only difference, but it is helpful to understand the platform in the context of current practices. For instance, multiple investors would participate in different tranches of a specific risk, much like reinsurers do today. This limits the investors’ loss exposure and gives them room to assume portions of other risks in additional tranches, increasing their portfolio diversification.
In essence, investors would create portfolios of different insurance liabilities, trading in and out of them as they see fit. Hence the “liquid” nature of Extraordinary Re’s trading platform. (See related Carrier Management article: Liquid Gold.)
With regard to the platform, the company worked with Nasdaq to adapt the firm’s proprietary matching-engine technology to suit its needs. While Nasdaq will host the platform, Extraordinary Re will manage the underlying transactions. “Will and his team came to us and expressed an interest in deploying our current technology platform to trade insurance-linked securities,” said Paul McKeown, senior vice president of market technology at Nasdaq Inc., a provider of trading, clearing, depository and surveillance solutions in addition to its well-known public company listing services.
Following Extraordinary Re’s launch later this year, the company plans to work with Nasdaq to deploy a blockchain-based ledger system to enable its investors to subscribe to real-time data feeds of transactions in the investors’ accounts at Extraordinary Re.
The blockchain technology will capture and transmit insurance underwriting and exposure data to the investors. “We’re giving investors access to more detailed and timely data than many traditional reinsurance companies ever see,” Dove said, adding that a possible future application of blockchain technology is the ability to create smart contracts between Extraordinary Re and insurer clients.
Pouncing on Cat Bonds
Aside from its strategy to create an insurance liability trading platform, Extraordinary Re is disrupting the catastrophe bond market by reimagining how investors and insurers/reinsurers come together to execute deals.
Three main parties currently are involved in the issuance of a catastrophe bond—a sponsor, the investors and a special purpose vehicle (SPV). Sponsors include insurance companies, reinsurance companies, large multinational corporations and governments—all looking to spread the risk of loss from hurricanes, earthquakes and other natural disasters. Investors generally are pension funds and hedge funds looking to diversify their investment portfolios with a new asset class. An SPV is typically a tax-exempt company that issues the catastrophe bond in a tax-friendly domicile like Bermuda, Ireland or the Cayman Islands.
Liquid Insurance Contracts
By creating a new nexus between the sponsors and investors, Extraordinary Re does away with the need for an SVP, offering liquid insurance contracts as opposed to a multiyear bond. For many investors, the ability to trade in and out of an investment position in an insurance liability will be more attractive than investing in a bond that doesn’t pay out for a certain number of years.
“One of the valid criticisms of catastrophe bonds is that there isn’t a lot of liquidity,” said Robert Hartwig, associate professor and co-director of the Risk and Uncertainty Management Center at the University of South Carolina’s Darla Moore School of Business. “While the yields might be relatively high and the risks are generally uncorrelated with traditional economic and financial risks, liquidity has been a weak spot.”
The lack of liquidity—the ability for investors to trade in and out of catastrophe bonds—made some institutional investors leery of catastrophe bonds as an asset class, he said. “What Extraordinary Re is doing is bringing together as many different market participants as possible to participate on its platform in a wide variety of insurance-linked securities that provide the same traditional benefits as high-yield and uncorrelated returns as cat bonds but with real liquidity,” said Hartwig, who teaches insurance and finance at the university. “The benefits of liquidity will expand the pool of investors and traders willing to participate.”
He added, “The fact that this is more than just catastrophic property damage risks also will be of interest, as it eases the way for institutional investors to create a portfolio of uncorrelated insurance risks.”
Not only can investors diversify their portfolios to include uncorrelated catastrophic property risks—the case for the past 20 years with catastrophe bonds—they now can further diversify their portfolios with a growing variety of other uncorrelated insurance liabilities like cyber exposures and mortality risks.
“There’s a lot of innovation going on here—not just the platform but also the company’s use of blockchain technology,” said Hartwig. “Most InsurTech startups tend to be involved in building a better mousetrap for distributing insurance. Extraordinary Re is bringing together new ideas in a completely novel platform that relies on several disruptive technologies.”
At the Helm
The company’s chairman and CEO is no newcomer to insurance. Across Dove’s nearly 30-year career in the property/casualty insurance and reinsurance industry, he’s been an actuary, underwriter and senior executive with such leading companies as Centre Re, ACE Ltd., Cigna, Continental Insurance and Tower Group International. At ACE, he was a member of the team that put together the company’s first ILS issue in 2007, giving him entrée to the capital markets.
Dove’s expertise is a key factor in Extraordinary Re’s appeal to deep-pocketed backers, among them Silicon Valley’s premier startup accelerator, Plug and Play Tech Center, an early investor in Google, Dropbox and PayPal. Asked what encouraged the venture capital firm to invest in Extraordinary Re, Ali Safavi, a Plug and Play principal and global head of InsurTech, said it was a combination of its leadership team’s domain knowledge of both insurance and the capital markets as well as the positive feedback the firm received from insurers and reinsurers it had contacted about the trading platform.
“We’re also aware that the model used today to spread risks is old and cumbersome,” Safavi added. “The technology is legacy, and innovation is needed. We also liked the connection to Nasdaq and especially the team’s connections with brokers, carriers, reinsurers and investors in the insurance and capital markets spaces. Ultimately, we felt they were approaching the problems from the right angle.”
The proof is in the pudding, which won’t be fully cooked until Extraordinary Re makes the leap from concept stage to actuality—possibly this summer, if all works according to plan.
Still, just the sheer invention at play evidences how new technologies will change the way insurance risks are absorbed and spread in the future.
This article was originally published in Wells Media Group’s Carrier Management, the magazine for property/casualty insurance carrier executives.
Was this article valuable?
Here are more articles you may enjoy.