Assets and Investment

Investment Returns

Investment returns are an under-appreciated aspect to insurance as it allows the insurance entity to earn returns on the reserves it holds. It is a key component to insurers’ profitability and therefore is a critical aspect for Nexus Mutual is able to compete with existing insurance entities longer term.
As Nexus Mutual holds all funds on-chain, it will restrict itself to assets of ETH and ERC20 tokens only. At present this asset universe is quite small but it is expected to grow substantially over time. The investment process is entirely automated using the Uniswap protocol to initiate trades.
Each asset that the mutual holds, apart from ETH, is set to have a Min Threshold and a Max Threshold, which represents the range in number of units of the asset the mutual can hold.
If the number of units is below the Min Threshold the mutual will trade ETH for Asset, if it is above the Max Threshold the mutual will trade Asset for ETH.
Any changes to the asset list and thresholds need to be approved by the Members through the governance module. Ideal assets would generate a positive return over time with very high probability, akin to the portfolio composition of traditional insurers which tend to be dominated by corporate and government debt instruments.
Overall Investment Strategy: Consistent with existing insurers, the investment strategy will be conservative with the aim of earning incremental returns without endangering the solvency of the fund. Additionally, it will be largely buy-and-hold focused to minimise trading activity and therefore fees.
In the Ethereum world, we see the current most appropriate candidates for generating a return as:
  • locking up ETH to generate interest in the proposed Proof of Stake system,
  • investing in financial instruments based on decentralised collateralised lending;
  • investing in interest-yielding decentralised money markets;
  • acting as a guarantor in state channel and payment channel networks;

Asset Liability Management

Entities with a known set of liabilities (such as discretionary mutuals and insurance companies) must hold assets to back those liabilities. The potential pitfalls associated with poorly matched assets in terms of liquidity requirements or exposure to economic changes poses several financial risks for these entities. Asset Liability Management (or "ALM" for short) refers to the practices employed to minimise those risks.
Most ALM strategies involve making sure that:
  • the change in the value of the assets on some basis is consistent with the change in the liabilities on the same basis, within certain tolerance limits; and
  • sufficient liquidity is available as and when it is needed.
For Nexus Mutual, at least initially, ALM considerations are not a significant concern, owing to:
  • The expected short-duration nature of Protocol Cover and Custody Cover, and
  • The initial currency assets being held (ETH and DAI) intended to match denominations of the covers written.
The initial Capital Pool asset raise following launch was be denominated in ETH. Upon successful completion of the Capital Pool funding, a portion of DAI (currently expected to be 5% of the initial pool) will need be purchased in order to enable the writing of covers denominated in DAI. As the cover portfolio matures, and the currency profile of the covers becomes clearer and more stable, the mutual will aim to match its currency holdings to its cover exposures as per the trading strategy.
In future, if Nexus Mutual begins writing longer-duration covers and/or employs a different investment strategy, the mutual should look to employ more sophisticated ALM methodologies.
A more detailed overview of common insurance ALM practices can be found here.