Securitization

Securitization is a financial technique by which a portfolio of assets, receivables, loans, or of risks, is transformed into tradable securities sold to investors on the capital markets. The operation generally goes through a dedicated vehicle, legally separate from the originator, which acquires the assets or bears the risks and issues in return securities whose return comes from the cash flows generated by the portfolio. Securitization lets the originator transfer a risk, free up capital and refinance itself, while offering investors access to risk classes otherwise hard to reach. In insurance and reinsurance, securitization is the mechanism underlying Insurance-Linked Securities and catastrophe bonds, through which an insurance risk is transferred to financial markets rather than to the reinsurance market alone. It can also serve to transfer longevity or mortality risks. Securitization has an ambivalent reputation, since its role in the 2008 financial crisis, through mortgage-backed securities, showed that opaque, poorly rated securitization can spread and amplify a risk rather than control it. Its virtue, the transfer and diversification of risk, therefore depends closely on the transparency and structuring quality of the operation.

A life insurer transfers a longevity risk by securitizing it, creating securities whose return depends on the actual evolution of the mortality of a reference population, bought by investors seeking diversification.

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