Brazil approves insurance-linked securities

Hopes to update insurance rules including introduction of insurance-linked securities will kickstart economic growth approved and will take effect from March.

Copy Of Copy Of FO Black 1200 (119) @Pixabay.
Brazil's Finance Minister looks to kickstart the country's insurance industry with ILS.

Brazil’s National Monetary Council (CMN) granted approval last week for regulations enabling insurers and reinsurers to raise funds from investors through the issuance of insurance-linked securities (ILS).

The CMN is the country’s highest economic body. According to Reuters, the Finance Ministry, whose minister is a part of CMN along with the Planning Minister and the central bank governor, said the ILS initiative will “diversify funding sources for these companies, enhancing the insurance market's coverage capacity”.

“The Brazilian economy has shown significant growth, with relatively low inflation compared to the world’s largest economies."

Finance Minister Fernando Haddad has previously said that the insurance market in Brazil is smaller than it should be.

Brazil's general insurance industry is set to grow at a compound annual growth rate (CAGR) of 7.3% from BRL242. 6 billion ($46.97 billion) in 2022 to BRL344. 9 billion ($68.03 billion) in 2027, in terms of direct written premiums (DWP), according to GlobalData.

“Since the end of the COVID-19 pandemic, the Brazilian economy has shown significant growth, with relatively low inflation compared to the world’s largest economies,” said a MAPFRE Global Risks report that documented the country's economic challenges and opportunities. “This situation has created good growth prospects for the insurance market, despite the fact that competition in the global risk market is very concentrated, because it is a very specialised line of business.”

Overall, Brazil’s economic growth is positive but sluggish. The latest OECD Economic Survey of Brazil from the end of 2023 said that GDP growth is projected to slow in 2024 to 1.8%, before picking up in 2025 to 2%. Domestic demand will grow at a more moderate pace next year as a result of tighter credit conditions and a mild global slowdown. The OECD also said that “Brazil needs to accelerate the green transition. To reduce greenhouse gas emissions, it should continue to strengthen the enforcement of the Forest Code to tackle deforestation, develop rural economies and incentivise innovation.”

“Public infrastructure is particularly vulnerable to climate shocks, and infrastructure investment is low in international comparison," said the OECD report. "Better planning, including tighter coordination across the federal and subnational governments, and reducing risks associated with long-run infrastructure projects has the potential to attract more private and international financing.”

Reuters said that under leftist President Luiz Inacio Lula da Silva, the government believes that new regulatory frameworks supporting the sector can stimulate much-needed infrastructure investments.

Inspired by insurance-linked securities, this new Brazilian counterpart, christened Letras de Risco de Seguro (LRS), was legislatively established in 2022 but lacked regulatory guidelines until now. The newly approved rules will take effect in March this year.

“Day to day we are getting a lot of calls from clients and institutional investors who are asking us what is going on in the market."

The investment returns tied to LRS are directly linked to insurance risk factors, specifically focusing on events like climate catastrophes in specific regions. In the absence of such events, investors receive their initial capital and a return. However, if the events occur, investors may experience losses. In essence, they bear the reinsurance risk and, in return, receive a coupon payment.

Insurance-linked securities were back in the headlines in 2023 after being ignored for several years, which experts said was due to the ongoing effects of natural catastrophes on the market. “Day to day we are getting a lot of calls from clients and institutional investors who are asking us what is going on in the market,” said Chantal Berendsen, Senior Analyst, Hedge Fund IDD, Albourne Partners, who added that she was often asked for her perspective on the pros and cons of the market in Clear Path Analysis’s report on ILS published in Q2 2023.

“People keep hearing that the market is interesting, but they want to know why, how, and what that means exactly,” she added.