A lottery company has turned to pension funds and other institutions to cover multimillion-euro payouts, in the latest sign that capital market investors are assuming ever more esoteric risks in the hunt for yield.
In what is thought to be the first transaction of its kind in the EU, Lottoland disclosed on Thursday it had issued so-called insurance-linked securities to protect it against the risk of punters hitting the jackpot.
The Gibraltar-based company is capitalising on a trend for investors to pile into ILS, which have offered chunky returns as the asset-buying programmes of central banks have depressed bond yields.
So far, the vast majority of ILS — which offer an alternative to traditional insurance — are based on natural catastrophe risks, such as hurricanes striking Florida. In total, capital markets investors have put up enough funds to cover an estimated $65bn of losses.
Insurers, actuaries and consultants have been exploring the potential for investors to take on a wide range of other insurable risks — from floods to pandemics.
Investors in the Lottoland transaction are putting up €100m. It has been structured to offer them four different levels of risk. Expected probabilities of losses range between one-in-8 and one-in-40, with commensurate returns of between 5 per cent and 15 per cent — depending on the risk involved, and the number of customers who make bets.
Lottoland can cover jackpots of up to €5m, with investors on the hook beyond that. The riskiest punter payouts for investors fall between €5m and €15m, so that tranche of the ILS also offers the highest return.
Backers said investors had been attracted to the lottery risks partly because they are uncorrelated not only with wider financial markets, but with other ILS, such as catastrophe bonds.
“There’s no other asset class like it,” said Nigel Birrell, managing director of privately owned Lottoland, which allows punters to place bets in competitions from Poland to Brazil.
“It gives greater security for us and our customers,” added Mr Birrell. “The odds are very calculable.”
The former bwin.party executive said the ILS would complement Lottoland’s existing insurance arrangement with traditional underwriters, including Lloyd’s of London.
“Theoretically the capacity [of capital markets] is much larger [than traditional insurance],” said Norbert Kranz of Frankfurt-based Inea, which structures such “non-correlated” investments. “Lloyd’s has its natural limits.”
Most ILS vehicles are domiciled in Bermuda. But other jurisdictions are trying tomuscle in. The Lottoland transaction is the first to be completed in Gibraltar, which is home to about 60 insurance companies.
Michael Ashton, a former Lloyd’s of London insurance veteran and now senior executive at Gibraltar’s finance ministry, said: “From an investor perspective, anything that contains a lot of information that you can give to modellers to work with would seem to sit well.”
Still, critics have questioned whether investors in ILS fully understand the risks they are taking on.