Insurance Linked Securities: Ledger Investing Breaks New Ground

By Russ Banham

Carrier Management

In the aftermath of Hurricane Andrew’s $15.5 billion in insured losses in 1992, insurance-linked securities emerged to distribute a portion of future property-catastrophe risk to investors. At the time, industry players contemplated the possibility of similar securitizations for casualty risks, but there was no Big Bang like a hurricane demanding a new source of risk-bearing capacity.

Even if there were, it would be difficult to persuade investors to bet on a risk that was opaque and challenged by scant and unreliable data, despite the opportunity to diversify investment portfolios with these uncorrelated probabilities. The foregone conclusion was that an ILS market that assumed casualty risks was a solution in search of a problem.

Samir Shah had other ideas. In 2017, Shah co-founded a platform called Ledger Investing, in which four casualty insurance risks—private passenger automobile, workers compensation, commercial automobile and general liability—are securitized and transferred to capital markets investors. Two years later, Ledger announced its first transaction.

Since then, the platform has notched over 60 deals, placing more than $300 million of gross premiums into the capital markets. Ledger will expand geographically beyond the U.S. this year, and possibly into other risks like health insurance. An important objective for the platform is for the securities it arranges to trade in the secondary market, with investors buying and selling the securities they own. “We started this because people said it couldn’t be done,” said Shah, CEO of Ledger, the world’s first casualty ILS fund.

To people who have known and worked with Shah over the years, they are not surprised he would buck common wisdom. “Samir has always been an extremely curious person, who closely and critically observed the status quo to understand why things worked the way they did,” said Charles Wolstein, a senior director in the Insurance Consulting and Technology business at WTW (formerly Willis Towers Watson). Wolstein and Shah were colleagues at WTW predecessor firm Towers Perrin.

Brad Fischstrom, who also worked with Shah at Towers Perrin, sketched a similar portrait. “Samir’s combination of technical, analytical and personal skills, along with his domain expertise, positioned him to connect casualty risks to capital in an entirely new way,” said Fischstrom. “To say he questions existing conditions is an understatement. He rocks them to their core.”

Finding His North Star

Born in Mumbai, India, Shah came to the U.S. at the age of 9 and grew up in northern New Jersey. As an undergraduate and graduate student at Northwestern University, his major was Operations Research, a branch of engineering that deals with the application of advanced analytical methods to improve decision-making.

He received bachelor’s and master’s degrees in Industrial Engineering and Management Science and was interested in finding a career in this chosen field of study. “I worked at a Dupont production plant in college and realized that [in order] to do really interesting engineering, I’d need a doctorate, which just meant more school,” he said. “Instead, I applied to an employee benefits consulting firm for a job, got it and found I liked it.”

The year was 1984 and the firm was Kwasha Lipton, conveniently located in Fort Lee, N.J. Shah worked in the defined contribution retirement plan design division, which developed the first cash balance plan—”a pretty big thing back then,” he recalled.

It was at Kwasha Lipton when Shah developed an interest in pension actuarial science. In his off hours, he studied to become an actuary. In 1992, he received his credentialing by the Fellow of the Society of Actuaries and transferred into Kwasha Lipton’s pension actuarial group. “Then, I got bored and took a couple years off,” he said. “I was taking courses at Outward Bound and thinking about becoming a counselor. I even considered opening a dive shop as I was really into scuba diving.”

Upon realizing the financial shortcomings of these career options, Shah decided to return to the consulting industry, just not as an actuary. In 1998, he hired on at Towers Perrin, then the world’s foremost HR consulting organization. There, he had the opportunity to apply his academic interest in operations research to solve business problems. “I took on all kinds of interesting consulting jobs, including one where I used queueing theory to design call centers for Yahoo,” he said. Queueing theory is the mathematical study of the formation, function and congestion of waiting in line.

His inquisitive mind led him next to risk management. Towers Perrin had merged in 1986 with Tillinghast, then the country’s largest risk management consultancy. “I kept hearing about something called ‘enterprise risk management,’” he said. “I was intrigued.”

He successfully applied for a transfer to Tillinghast, which set him up with several large banking clients in the process of implementing Basel II regulations. The banks were looking to establish an ERM framework, which they perceived as a more proactive way to assist compliance with the international banking accord. “As I modeled risks for these clients, I began thinking about combining operational risks in a portfolio with other risks like credit risk, FX (foreign exchange) risk and strategic risk.”

He was ahead of his time, as ERM soon attracted industry interest beyond the banking sector. Moreover, to coordinate the implementation and management of ERM, a new role was created: chief risk officer (CRO). Given his knowledge of ERM, Shah looked for work in this position, eventually leaving Towers Perrin in 2007 to become CRO at global life reinsurer Scottish Re. “The company had an interesting business model, buying up huge blocks of life insurance and structuring and securitizing these risks to earn a spread,” he said.

Unfortunately, the reinsurer’s timing was terrible, as the subprime mortgage crisis was about to explode. “We had huge securitizations invested with Lehman Brothers; when the market blew up, so did our securitization vehicles,” Shah said.

He moved on again, this time as group CRO at Validus Holdings Ltd., a leading provider of reinsurance and asset management services. In January 2010, he joined AIG as its first CRO and implemented the giant insurer’s ERM function. (AIG later acquired Validus.) Shah also developed and directed the insurer’s capital markets strategy, which included a $3 billion property-catastrophe bond program recognized as one of the largest in the ILS market.

Spending much of his time talking with investors about diversifying their investment portfolios with uncorrelated property-catastrophe exposures, an inspiration struck. “I began thinking that when people slip and fall at work or get into a car accident, these risks also are uncorrelated,” he said. “I reached out to some investors I knew and asked them, ‘If I could create an ILS platform for casualty, will you come into the market?’”

The Birth of Ledger Investing

This “if you build it, they will come” dream impelled Shah’s resignation at AIG in November 2015. Nine months later, he launched Ledger Investing. The InsurTech startup relies for business on managing general agencies holding the underwriting pen for specialty insurers.

“An MGA submits a portfolio of policies like workers compensation, for which they are responsible for origination, underwriting and claims management,” Shah explained. “The MGA hires a fronting carrier to issue the policies and then arranges with Ledger to provide reinsurance on the policies.”

By reinsurance, he is referring to the financial instrument transferring the specialty insurer’s workers compensation risks to institutional investors like hedge funds and sovereign wealth funds. (Shah declined to provide the names of the investors.) Ledger directly connects to the MGA’s policy underwriting and claims data via application programming interfaces (APIs), assuming the company has provided access.

This transparency is an important feature of Ledger’s differentiating value proposition. Unlike an insurer that uses machine learning algorithms to analyze insured risk, Ledger uses stochastic modeling to analyze investment risk. Stochastic modeling is used by portfolio managers to analyze levels of unpredictability in an asset fund. Ledger uses other sophisticated investment risk tools like Bayesian modeling, time-series forecasting and probability distribution theory, in which the probabilities of different possible outcomes are measured. “Not only is [the MGA’s] data transparent, our analytics also are transparent to investors for them to judge the strength of the math,” Shah said.

Ledger also can securitize risks for reinsurers as an alternative to traditional retrocessions. The risk transfers are structured on an annual basis, as opposed to the multiyear duration of most property-catastrophe bonds in the ILS market. “Whereas property-cat risks are long-term exposures, the volatility associated with casualty risks is on a weekly, monthly and annual scale,” Shah said.

Other than an alternate way to transfer risk, what’s in it for the insurance and reinsurance markets?

The answer is capital size and clout. “The reinsurance industry has about $500 billion in capital across property/casualty, life and health insurance globally, whereas the investors we talk with have a pool of $80 trillion to $100 trillion of capital globally,” said Shah. “Quantity has a quality all its own.”

The capital markets’ bigger pool of money gives investors the ability to absorb “all kinds of risk concentrations, something the reinsurance industry cannot do,” Shah maintained. “Say a reinsurer has $10 billion in capital. That severely limits its ability to assume the risk of an event that could generate, say, a $100 billion loss. For the capital markets, $100 billion is next to nothing when you’re talking tens of trillions of dollars of investment.”

What’s in it for investors?

For one thing, they can invest in a portfolio of uncorrelated risks in a single category like workers compensation or a combination of the four insurance lines supported by the platform. Regarding the return, Ledger’s ability to access and model casualty risks and cash flows allows it to offer “targeted” investment returns to investors that account for the time-value of money—the future value an investor expects from their investment, said Shah.

Another factor in these returns is Ledger’s operating costs, which are lower than reinsurers’ operating costs, Shah maintained. “In the reinsurance industry, 3-7 percent of the premium covers their overhead,” he said.

Asked what accounts for the platform’s lower operating costs, Fischtrom, who joined Ledger as chief operating officer in late 2020, pointed to the insurance industry’s “information asymmetry.” He explained that underwriters collect a lot of information on a risk, but in passing this unstructured data to reinsurance brokers, reinsurers, investors and other links in the insurance value chain, “the data intricacies are lost, creating the need for supplementary underwriting analyses.”

Ledger obviates this problem through its “automated real-time data pipeline, directly from the risk originator to the capital providers, overlaying [this information with] objective, data-science-driven stochastic modeling to provide a full depiction of potential portfolio outcomes,” Fischtrom added.

As for the role of the MGAs in this revamped value chain, Shah said they receive a commission akin to the commissions paid a reinsurance broker. Typically, an MGA testing Ledger as a risk transfer mechanism offers the platform roughly 20-25 percent of the reinsurance or retrocession placement, with the remainder of the risk placed with traditional markets, he added.

Ledger also obviates the capacity issues that create business risks for MGAs, Shah said, citing decisions by insurers and reinsurers to alter their commitments on specific risk assumptions at policy renewal time. “That doesn’t happen here; we eliminate that business risk and existential threat to MGAs,” he asserted.

What’s Ahead?

Given that Ledger has placed more than $300 million of gross premiums into the capital markets, it would appear this late-to-the-party alternate method of transferring casualty risks has a decent future ahead of it. The question is, why not sooner? “It was only a matter of time before the ILS market tiptoed into the casualty side of the business,” said Robert Hartwig, PhD, Clinical Associate Professor of Finance at the University of South Carolina, where he leads the Risk and Uncertainty Management Center.

By “tiptoed,” Hartwig pointed out that three of the four casualty lines of insurance that Ledger transfers to investors are the “plain vanilla” of the casualty business. “Workers comp results are probably the most stable of all major commercial lines today and are likely to remain the case for a few years,” he said. “Personal auto, the largest of all property/casualty lines, also is relatively stable, as is general liability.”

On the other hand, commercial automobile insurance, especially policies covering trucking and ride-sharing companies, is problematic, Hartwig said, explaining that the key to Ledger’s success “appears to be the annual nature of their securitizations. A single year of investment risk allows the pricing to be more flexible than the structure typically seen with three-year catastrophe bonds. That should take some of the worry away for investors.” Nevertheless, he cautioned that as interest rates rise this year, the higher rates of return may appeal more to investors than “a risky bet on commercial auto insurance.”

Apprised of the comment, Shah demurred, explaining that if the risk-adjusted returns for investors increased in other asset classes, the pricing and yields in the ILS market would correspondingly increase. “There’s always competition for capital across markets, with money flowing in and out and causing returns to be higher or lower. All markets ebb and flow,” he said.

The people who have known and worked alongside Shah believe he has invented a better mousetrap. “He’s peeled back everything to the fundamentals, increasing transparency in the ways that risks connect to capital in the reinsurance space,” said Fischtrom.

Wolstein’s even longer association with Shah suggests that his development of Ledger was predestined. “At the end of his tenure at Towers Perrin, he was doing a lot of capital modeling and risk modeling, well before others did the same things,” he said. “Looking back at the breadcrumbs, one might reasonably conclude he’d lead something that would disrupt the insurance industry.”

Hartwig, who has never met Shah, appears to share this opinion for the time being. “He’s hit upon an interesting innovation, but I would also characterize it as experimental,” he said, noting that it took the property-catastrophe ILS market a quarter-century to find its footing.

“I don’t see Ledger securitizing the wider casualty area, transferring difficult risks like environmental liabilities, professional liabilities and cyber risks,” he added. “But I do think he’s onto something in securitizing insurance lines where there’s an enormous amount of data available for modeling.”

Time will tell.

Russ Banham is a Pulitzer-nominated journalist and best-selling author.

Leave a Reply