Liberty Specialty Markets offers specialty and commercial insurance and reinsurance products across key UK, European, Middle East, US and other international locations. We provide brokers and insureds with a broad range of products through both the Company and Lloyd’s markets and have over 900 staff in 25 offices. Liberty Specialty Markets was established in September 2013 bringing together Liberty’s company, syndicate and reinsurance operations into one combined operation, composed of three business units: Commercial, Specialty and Reinsurance. This integrated approach means brokers and clients can benefit from our global reach and operating efficiencies
Liberty Specialty Markets is part of global insurer, Liberty Mutual Insurance Group, a diversified global insurer, formed in 1912 and headquartered in Boston, Massachusetts. A U.S. Fortune 100 company, Liberty Mutual operates around the globe offering a wide range of insurance products and services, with more than 50,000 employees in over 800 offices throughout the world. The company is the fifth largest property and casualty insurer in the U.S. based on 2015 direct written premium data as reported by the National Association of Insurance Commissioners. It is ranked 73rd on the Fortune 100 list of largest corporations in the U.S. based on 2015 revenue.
Using insurance to reduce risk in financial transactions
The financial upheavals of the noughties have led to wide-ranging global regulatory reforms that compelled financial institutions to make sweeping changes. In parallel, shareholders are demanding better returns on their capital. Liberty Specialty Markets (LSM) explains how their ground-breaking insurance is helping ease banks’ pain while positioning LSM as a market-maker in this space.
Since the financial crisis, regulators around the world have asked themselves the question: ‘How do we prevent this from happening again?’ The answer has been a swathe of regulation and legislation designed to prevent corporate failures and imploding balance sheets – Dodd-Frank, Solvency II, the Mortgage Credit Directive. For many financial institutions, the net result has been dramatically increased regulatory capital requirements, which tie up funds that could be used to earn a return in other ways. It is this growth in capital requirements that led us to ask ourselves the question: ‘How can we, an insurer, help banks to use their capital more efficiently?
When LSM’s Structured Risk Solutions team was set up four years ago – a combination of legal, underwriting, tax, capital markets and actuarial expertise – we initially focused on providing cover for transactional risks associated with corporate acquisitions. Unusually for the insurance market, buyers of this type of cover were not concerned about the exposure “per se”.
For example, a private equity (PE) fund may have wanted insurance against breach of warranties in a share purchase agreement (SPA) not because it was fearful of implications of a breach, but because having the insurance in place allowed it to distribute the proceeds of the sale to investors more rapidly. The insurance mitigated the need to hold back capital for any contingent liabilities arising from the SPA and was simply motivated by a desire on the buyer’s part to use insurance strategically so that capital could move on more quickly.
Having amassed considerable experience of transactional risk, we resolved to identify other types of transactions around which we could leverage the team’s skills, experience and risk appetite. This led us to look at structured credit risks – specifically risks with strategic capital relief drivers such as securitisation exposures, risk transfer on structured credit portfolios and securities lending.
In the case of securitisation, historically, banks have provided liquidity facilities and interest rate swaps to unrated securitisation vehicles. In cases where the securitisation vehicle’s underlying notes are downgraded – as happened frequently following the global financial crisis – a bank is required to hold a significant amount of capital against its exposure to the vehicle. This was an issue which needed an alternative and innovative solution, which was precisely what we set about finding. The answer was that by purchasing a policy to insure its exposure to the unrated entity and effectively substituting a credit risk to an unrated company with a credit risk to a well rated, stable insurer, we could help the bank greatly reduce the capital it needed to hold against the exposure – by transferring risk to us.
Another type of business affected by increased capital requirements is a securities lending agency – a firm that arranges securities lending transactions for third parties. Securities are lent by one business to another so that the borrower can use them as part of a hedging strategy, with the agent acting as broker. Securities lending agents have had to indemnify their lending clients against the risk of the borrower defaulting, hence the need to hold capital against the likelihood of that indemnity being called upon. Basel lll and its implementation in the US through the Dodd-Frank Act significantly increased this capital requirement. We took the view that insurance could be used to backstop the indemnity, thus reducing the volume of capital needing to be held. Alternatively – and even more innovatively – we realised that a policy could be offered to the lending client to replace the securities lending agent’s indemnity, thereby transferring the risk in its entirety to us.
Historically, the only option available to deal with certain exposures or risks such as these would have been to involve an unrated counterparty that is able to buy the exposure or provide some form of collateralised protection which is more expensive as cash has to be deposited against the risk on day one.
The insurance solution, by contrast, only needs to provide cash if the policy is triggered as the insured client is transferring risk to a well rated, regulated counterparty. This in turn enables LSM to offer better value and provides a long term, stable risk partner for clients.
This innovative approach combined with LSM’s unique underwriting perspective explains why the Structured Risk Solutions team has built its reputation within a number of well-known financial institutions as a market-maker and pioneer in this area. It’s also why we are now able to offer significant levels of cover across a variety of risks, jurisdictions, and asset classes.
Today, we focus on all types of credit exposure that cause concern to financial institutions. These include a broad range of assets including:
- Interest rate swaps
- Derivative instruments
- Securitisation exposures
- Securities financing transactions including securities, loans and repos
- Warehouse lending and alternative financing
- Large corporate and SME loans
- Mortgages and REITS
Taking a principled approach
Whatever the structure and the exposures, we take a principles-based approach to our underwriting. The team’s guiding underwriting principle is that the solutions we devise should be used by insured clients to help achieve their strategic objectives – such as minimising the amount of capital they have to hold against risks on a loan portfolio, releasing capital from escrow or facilitating transactions designed to support the wider business – rather than being driven by a concern over the underlying risk.
Consequently, the team spends a lot of time on up-front due diligence to understand client strategy and ensure LSM’s interests are aligned with those of the customer and that we are not simply gaining exposure to poor quality risk. Because LSM’s appetite is to cover tail risk, the due diligence must also show that an asset class would need to experience a catastrophic risk before LSM’s solutions would come into play.
The advantages of the approach to the insurance buyer are two-fold. First, the time spent working closely with insureds in underwriting the cover often lays the foundation for a long-term, mutually beneficial strategic and stable partnership. Second, our principles-based framework enables us to act less like a traditional insurer and more like a financial counterparty reinsuring a client’s processes and risk management, offering more flexible and adaptable solutions.
Unique perspectives for unique situations
So, provided the due diligence stacks up, there is a strategic driver for the cover, the risk insured is financially catastrophic, and there is no reputational or regulatory risk to LSM, we are able to put our team to work to provide meaningful and innovative solutions to clients’ needs. The challenge now is to bridge the traditional disconnect between banking and insurance, to familiarise more banks and other institutions with this novel approach to credit protection and to build more long-standing partnerships.
As we move forward, our expectation is that growth will come from portfolio credit risk transfer and the asset management sector. But wherever the focus lies, LSM Structured Risk Solutions will continue to drive most success where it is able to deploy a listening ear, flexible approach and unique perspective.
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Liberty Specialty Markets: We’re passionate about doing things differently to help our clients, staff and communities to prosper
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