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RISK FINANCING ALTERNATIVES SLOW TO CATCH ON

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LONDON-New alternative risk financing methods are capturing risk managers' interest but not their business in any substantial way, a broker says.

A combination of highly competitive rates in the current soft insurance market and risk managers' preference for captives rather than capital market options has stalled the much-trumpeted demand for non-traditional sources of risk financing.

Morton Lane, president of Sedgwick Lane Financial L.L.C. in Chicago, a unit of Sedgwick Group P.L.C.'s reinsurance broker, lay the blame at the feet of the buyers.

"Many people are cynical," he said. In addition, some alternatives, such as insurance and reinsurance securitization, are not fully understood, he said.

Nevertheless, interest in the alternative markets heated up during 1996, with an increasing number of deals proposed. Not so hot was the level of success. For example, three major insurance-capital markets transactions proposed last year-including ones by ACE Ltd., Cat Ltd. and United Services Automobile Assn.-failed to come to fruition, Mr. Lane said.

"It was a low point indeed for the revolutionaries," he said during a conference in London last month on "Capital Markets Risk Financing in the Insurance Industry."

In addition, the reinsurance industry trumped the capital markets late last year when Berkshire Hathaway Inc. stepped in to write a $1.5 billion layer of reinsurance for the California Earthquake Authority that initially was to have been financed through a bond issue (BI, Nov. 25, 1996).

"Some say it was a deliberate policy by the reinsurance industry," observed Mr. Lane, "that it does not want to see capital market incursions into reinsurance."

Despite such setbacks for the capital markets, by the end of 1996 three deals had been completed:

American International Group Inc. completed a deal in May, raising an estimated $25 million through a portfolio of property catastrophe-linked bonds. The bonds will react to catastrophic losses in the United States, Japan, Australasia, the Caribbean and western Europe, providing a hedge for AIG's cat exposures in those areas.

St. Paul Reinsurance Co. closed a $68.5 million securitized reinsurance deal in December, using a mixture of bonds and preference shares to provide reinsurance capacity for up to ten years from a single purpose reinsurance company, George Town Re.

Hannover Reinsurance A.G. in December raised $100 million through the use of a portfolio-linked swap with a small group of unidentified North American institutional investors (BI, Dec. 9, 1996).

In early 1994, Hannover Re completed a similar $85 million transaction, making the organization the "first successful double-dipper in the capital markets," according to Mr. Lane.

But, in general, experience last year risk financing from the capital markets was patchy, he said.

"It was a year of frantic activity and as yet unproven results," commented Mr. Lane.

"Nearly all the major U.S. investment banks have participated in 1996," he said. "All those major investment banks suffered a failure during the year."

Smaller specialist companies may have more success in the field, he predicted.

Already, though, 1997 is squaring up to be a busy year for capital markets transactions.

Three new deals have been proposed, plus the anticipated proceeds of a proposed catastrophe bond to be issued by Winterthur Swiss Insurance Co. has already been raised to 399 million Swiss francs ($279.9 million) from 300 million Swiss francs ($210.5 million).

Of the three that didn't complete their deals last year, USAA is currently refiguring its bond issue and both ACE Ltd. and Cat Ltd. are continuing to investigate possible capital market transactions.

Meanwhile, officials of the Princeton, N.J.-based Catastrophe Risk Exchange are talking with representatives of the Bermuda Stock Exchange on a proposal to set up a Bermuda operation for insurers to trade tranches of catastrophe risks.

CATEX is "the logical link between capital markets and the insurance industry," said Frank Fortunato, vp of CATEX. What's more, "the (insurance) industry seems to be lining up willingly to capital markets," he added.

CATEX operates as a computerized trading floor where primary insurers, reinsurers, intermediaries and self-insureds can trade tranches of insurance risks, such as a book of property business exchanged for a book of auto liability risk.

"The concept was originally limited to exchanging 'spikes' of portfolios between U.S. primary companies," explained Mr. Fortunato, starting with exchanging property catastrophe risks, but it has been extended to trading annuities, workers compensation and environmental liability business.

So far, the exchange has had four risks posted, none of which has yet been traded. Nevertheless, CATEX has "more than 23 subscribers," said Mr. Fortunato, including some of the big names in insurance and reinsurance. CIGNA Corp., Travelers/Aetna Property Casualty Corp., Swiss Reinsurance Co. and Employers Reinsurance Corp. are all members, as are some large corporations, including electric utility Enron Corp.

"Once (CATEX) is trading and the sale of insurance begins to develop, there is an opportunity for real-time indexes on a minute-by-minute basis," explained Mr. Fortunato. This could have real appeal for the capital markets, which in the past have complained that insurance pricing has been unknown.

Through providing this information, CATEX may be able to help prepare companies for entry into the capital markets arena, said Frank Sweeney, also a CATEX vp. "The core of the market is pricing data," he explained. "There is tremendous interest in pricing risk." And that interest has noticeably shifted over the past couple of years, inspired by the rush to manage exposures down in the tail of Hurricane Andrew.

This has led to a much greater interest in taking on the risk, but the assuming companies want to know what constitutes a good price. "A flow of real-time information can influence the prices," said Mr. Sweeney.

Ultimately, time will be the test of the capital markets' incursion into risk-taking, whether through mechanisms such as securitization or exchanges. "It is a fragile revolution," said Sedgwick Lane's Mr. Morton, "and no one is quite sure where it is taking place."