Here is some guidance on what you should consider “too good to be true”. Most smaller operators or start-ups are looking to buy insurance cover for one year; the typical duration of a normal prize indemnity policy. Below we focus on this segment.
More sophisticated buyers which deliver significantly large volumes have access to multi-year structured insurance policies which have multiple advantages. If someone offers you a multi-year, structured insurance policy for less than 800,000 (EUR, GBP or USD – the major policy currencies) p.a., then stay away – too good to be true. The serious players in the structured insurance market are all rated and have massive balance sheets. For good reason, they need to be around in a few years as they wrote multi-year policies.
Let’s look at the current risk-free interest rates in the major policy currencies – nothing is truly risk-free anymore, but government bonds from major some Western countries are still portrayed that way.
- USD: Between 4.4% and 4.8% (US Treasury bond)
- GBP: Between 4.1% and 4.6% (UK Gilt)
- EUR: Between 2.6% and 3% (German Bund)
Prize indemnity risks are a little like Cat-Bonds – chunk bonds. For the higher risk to lose his investment, the insurance investor expects a higher yield than the risk-free rates offer.
For an operator in a developing country, a EUR 5m cover may be sufficient. In more developed countries, the operators will want to offer insured jackpots of at least EUR 10m, more likely 20m – 50m. Jackpots above EUR 50m almost exclusively occur in the big 5 lotteries: US Powerball and MegaMillions, EuroMillions, Eurojackpot and Superenalotto.
Let’s get the covers of 50m or more out of the way. If someone offers you such a cover for less than a minimum of EUR 2m p.a. then stay away: too good to be true. Be aware, I am not saying that a minimum payment of more than EUR 2m is a clear indication of non-fraudulent behaviour. Between 2-4m you still have to check the insurance vehicle carefully. For good reason, you are relying on them to potentially pay out 50m! The most recent transactions from reputable insurance companies in the 50m cover space are above 4m p.a. This is what the insurers call an 8% minimum rate on line (the line being the 50m limit they offered). The 4-5% risk premium above the risk-free rate seems reasonable for potentially losing the investment.
Now on to policies with lower limits.
There are two components to the price, i.e. the premium:
- The Minimum Deposit Premium (MDP) which is the minimum premium an insurer requires to provide the policy. This covers the insurer’s operating costs and protects him against smaller operators not providing enough volume to generate a reasonable premium income.
If an insurer offers you an MDP of less than 150,000 for more than 5m limit, then stay away: Too good to be true. Then there is the grey zone of 150,000 – 200,000 MDP. Possibly fraudulent, possibly fine – needs to be checked carefully. Fully regulated, rated insurance companies currently charge at least 200,000 – 250,000 p.a.
The MDP is seriously restrictive for start-ups. We are developing an insurance product (fully regulated, rated capacity) with approx. 100,000 MDP. Where is the catch? It won’t be a bespoke, individual policy. It will be an off-shelf group policy which multiple operators can share in order to avoid the MDP liquidity squeeze.
- The risk-based premium is calculated based on the volume of bets and the insured amount of these bets. If the risk-based premium exceeds the MDP, then the operator has to pay a top-up premium. The most frequently used parameter to price the risk-based premium is a multiple times the expected loss of a bet.
Years ago, the market offered multiples around 1.6, or a 160% of the expected loss. Then for a short while it increased to 1.7 – 1.9 and currently, due to big losses in the prize indemnity market, the multiples are more like 1.9 – 2.1.
If someone offers you a multiple of 1.5, then you should seriously ask yourself: too good to be true?
Most operators are very focused on the multiple, but the MDP is for most of them more of an issue. The multiple kicks in if you deliver the volume and if you deliver the volume, then you generated revenue. The MDP is a cash out independent of volume and if you don’t deliver the volume, then the insurance premium per bet could be significantly higher than assumed in margin calculations.
Humans are by nature very irrational. Try to be rational and check the facts or involve professionals who do this for you before buying an insurance policy.
Markus Stricker