How Can I Invest in Insurance Risk?

Insurance is a profitable industry that is complicated and opaque. Those that understand insurance risk are able to participate in these profits through insurance-linked investments. We aim to bring transparency and understanding to the everyday investor on how to participate in this industry.

In my capacity as an Actuary, I deal a lot with the transfer of insurance risk. The insurance industry is a fascinating web of financial transactions with a largely intangible product. There are many layers between the insurance company who you receive a policy from and pay a premium to, who is ultimately responsible for paying your claim, and who is making a return on capital invested.

A question that's been lingering in my mind for a while now - how can I invest in insurance risk as an individual? In this modern age of retail investors taking control of their own investments, is it possible for me to allocate a portion of my portfolio to insurable perils?

Funny enough, this is actually how modern insurance was originally formed. When Lloyds of London started out in the 1600s the capital backing those policies came from Names - wealthy individuals who took on the risk of paying claims in exchange for the premiums and potential profits from those policies.

The unlimited liability of these Names eventually proved to be unsustainable and lead to the modern system of sophisticated corporations with capital requirements and statistical modeling (read Andrew Duguld's On the Brink: How a Crisis Transformed Lloyd's of London1for a fascinating first-hand account of this history). Along with that, developments in reinsurance structuring and securitization has allowed non-insurance companies to participate in insurance risk through products like catastrophe bonds.

Insurance companies sell a product based on trust. Policyholders trust is in the ability for the insurance company to pay claims. This trust is substantiated by the financial backing of the insurance company. Think about your car insurance policy. Perhaps you're paying an insurance company $1,500 a year with the expectation that if you're in an accident, they'll pay out for a $10,000 repair claim, and maybe a $25,000 liability claim. Clearly, the you're expecting a much larger payout than what your premium costs in the event of an accident, and so is every policyholder.

Hopefully the insurance company will take in enough premiums to cover the claims, and the company will make a profit. This is the basic idea of insurance. However, if the insurance company is not able to take in enough premiums to cover the claims, it still needs to pay out claims. This is where the concept of Policyholder Surplus comes in. In short, this is a pool of money that is available to pay out claims, which is over and above just the premiums collected.

Policyholder surplus is built from several sources:

Riskvest's mission is to highlight these opportunities for retail investors to access what has traditionally been institutional-only alternative capital markets. While these products are few and far between, developments in the space have opened up new opportunities for us to get involved.

When investors participate directly in insurance risk (rather than just owning insurance company shares), they are compensated for taking on this risk in a similar manner to how they would if they were an insurance company themselves.

The two main components of returns from insurance risk are underwriting profit and investment income. Underwriting profit results from the difference between the premiums collected and the claims paid and expenses incurred.

Insurance companies generate investment income from investing the policyholder surplus. For these specialized products, investors similarly receive investment income returns on the capital they have committed.

Once the policies your capital is backing expire, claims & expenses are settled, and the insurance company has determined no further claims will come through (no further insurance risk), the capital is released2back to the capital providers and a final return is paid out.

Of course, all investments carry risk. In this case, underwriting risk is the risk that premiums collected are less than the claims paid and expenses incurred. When this happens, investors may lose some or all of their principal, not just receive lower returns. This direct loss exposure is what distinguishes these investments from traditional insurance company stocks. While it's not uncommon for an insurance company to make an underwriting loss, advancements in actuarial science and pricing have led to the insurance industry better understanding the likelihood of this happening and communicate those expectations to investors.

Insurance is considered to be a sophisticated risk. Learning the ins and outs of how underwriting, claims and investment income work is a career-long process even for those who work in the industry. Accordingly, regulatory bodies have strict requirements for most insurance backed investment products.

With that said, opportunities for retail investors to participate in insurance risk do exist, and Riskvest aims to highlight those opportunities. To foster the development of this space, Riskvest is also committed to sharing our research and insights with the community through four core pillars:

I hope you share my excitement for the potential of insurance risk as an investment opportunity. If you have any questions or feedback, please don't hesitate to reach out on LinkedIn or via email at contact@riskvest.io.