Insurers face tough regs and tight pricing in fight to carve out SRT niche

As the number of participants in the significant risk transfer (SRT) market has grown, insurance companies have spotted an opportunity.

A survey of 14 insurers and reinsurers by the International Association of Credit Portfolio Managers (IACPM) earlier this year found that, between them, they had insured €2.8bn of European SRT transactions in 2024 — up from €1.2bn the year before.

“There’s room for growth in the insurance sector of the SRT market,” says Nanak Keswani, partner at Mayer Brown in London. “Insurers have the ability to be a key component of the market. Underwriting and assessing risk is part of their DNA.”

While that growth comes from a low base, there is growing awareness of what insurers can offer.

“Issuers are looking for different goals with each transaction,” says Som-lok Leung, executive director of IACPM. “They already shop amongst funded investors, but now they’re also shopping more among unfunded investors, or at least they’re willing to look into it. There are also more insurers who know about this and are interested now.”

Yet, taking advantage of opportunities is not always straightforward.

Insurers generally have a lower cost of capital than credit funds, so theoretically they should be able to offer tighter pricing. However, the two types of institutions prefer to structure deals in different ways, and these at least partially offset the pricing advantage.

Most importantly, asset managers provide cash up front, whereas insurers only pay out in the case of losses. Insurance investors can buy highly rated, liquid securitizations with cash for the asset side of the balance sheet, but that is not suitable for SRT. Instead, they have a different team to underwrite SRTs as insurance business on the liability side of the balance sheet.

Hence a typical insurance transaction, dubbed ”unfunded”, introduces counterparty risk, reducing efficiency of risk transfer for the issuer. Rather than getting collateral to cover losses, a bank has to swap the risk of the placed tranche with the credit risk of the insurer.

Regulations also steer the market towards funded trades, as in many jurisdictions unfunded transactions do not qualify for capital relief. Indeed, only in the last year has the Bank of England’s Prudential Regulation Authority (PRA) begun to warm up to unfunded trades, while in the EU they are allowed but ineligible for an ‘simple, transparent, standardised’ (STS) stamp and the capital benefits that brings the issuer.

The result is that insurers are only a small section of the market in Europe — 5% according to 2023 data from the ECB.

Some promising developments, however, include a blossoming of structures that both allow a bank to get a funded investment and an insurer to underwrite credit risk without putting up collateral — though most insurance investments are still done on an unfunded basis.

Such structures, known as repacks, require another party to put up funding. That party, usually another bank, is left with exposure to the insurer.

Repacks can give insurers access to the STS market, allowing them to compete for deals against asset managers.

“Some of the specialist and/or larger insurers and reinsurers have become more relevant, but maybe not in the way that was expected,” says Robert Bradbury, managing director at Alvarez & Marsal in London. “I think a lot of people expected a separate unfunded market to develop with a cheaper cost of capital but perhaps slightly less efficient risk transfer. [In fact, insurers have gained a foothold], by competing on the same terms as everybody else.”

Repacks, however, are not easily scalable, since the structures are complex and the terms bespoke — ironic, perhaps, given they are what is required to meet the STS standard.

There is live debate in the EU over extending the ‘STS’ stamp to unfunded deals. Though the idea has broad industry support, it is not universally popular, with critics highlighting the counterparty risks of an insurer being downgraded or unable to pay a claim.

Adding more transaction parties also increases execution risk, particularly as SRT deals normally take months to put in place.

“[For a repack], you need to align the issuing bank, the insurers, and the funding provider,” says Olivier Renault, head of risk sharing strategy at Pemberton in London. “When the market moves, everyone’s costs can go up and down. We do see deals but it’s not yet a meaningful portion of the types of transactions we focus on.”

Insurers are a small part of the market for corporates but play a bigger role in some sub-sectors such as mortgages.

The complexity is also a hurdle given demand is outstripping supply. Banks do not need to go out of their way to find more demand for their SRTs. The set-up favours larger players, who can bring certainty of execution, perhaps by working with consistent funding partners.

“A lot of the more ad hoc repack vehicles have had more direct competition recently,” Bradbury says. “An insurer needs a cost of risk to be substantially cheaper than the rest of the market to make it competitive on a like for like basis, given costs of funding. Your cost of risk plus your cost of funding has to come out at least the same everybody else is pricing. Given where pricing reached, insurers have to be relatively risk-on as an insurer to make it work.”

Although tight spreads are squeezing some insurers’ ability to compete on price, indirectly they may open up opportunities to underwrite senior mezzanine tranches.

Many credit funds invest on an internal rate of return (IRR) basis, which means — as spreads have moved tighter — they have had to look for ways to eke out higher returns. A significant minority have been using bank leverage, mostly through repo.

This has met considerable backlash from opponents who argue that the use of bank financing increases systemic risk, because risk offloaded in SRT transactions is re-entering the banking system.

Proponents of banks financing SRTs disagree, arguing the risks of repo financing are far lower than holding the portfolio itself. They highlight several mitigants, including shorter tenors, recourse to the fund itself and daily margining.

Still, the backlash itself is impacting the market. Some banks have cut the amount of financing they provide on SRTs, while others have placed restrictions or disclosure requirements on how investors finance their deals.

Regulators are also interested. In October 2024, the International Monetary Fund warned that bank leverage on SRTs could “retain substantial risk within the banking system but with lower capital coverage”.

The ECB put out a statement along similar lines in February, while the Bank of England warned in April that, for certain portfolios, some banks had adopted “an imprudent approach” by including the lending in their trading book not their banking book.

By all accounts, an outright ban on bank leverage is unlikely. Indeed, the Bank of England’s statement appeared to accept the principle of such financing if appropriately capitalised.

But there are certainly some looking for alternative forms of leverage. For insurers, it creates an opportunity to work alongside funds. The insurer can guarantee a senior mezzanine tranche, giving the fund structural leverage on its investment lower down the capital structure.

It works because insurers’ business depends on pricing risk rather than the IRR approach taken by many asset managers.

“I think equity tranche [SRT] in insurance form should, for the most part, be fully collateralised,” says Matthew Moniot, co-head of credit risk sharing at Man Group in London. “Unfunded insurance brings greater value at senior mezz where losses are relatively remote, and so it’s harder to justify full collateralisation.”

IACPM’s survey reports “very limited” appetite for the first loss piece of the deal but suggests a growing number of junior mezz investments — 48% of participants in 2024 compared to 27% in 2022.

“There are definitely some insurers who do first loss, but it’s not common,” says IACPM’s Leung. “It depends on their risk appetite. Most of the time they don’t want to be in the expected loss.”

However, Georges Duponcheele, senior credit portfolio manager at Munich Re, pushed back on the idea that insurers should confine their activities to higher up the capital structure. He argues that insurers could provide guarantees anywhere in the stack, as long as they were able to price the risk.

He adds that “insurers like to be close to the risk” to allow them better understanding of when claims might be made.