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MEXICO CITY-The insurance industry could be on the cusp of a new era in risk financing with the successful placement of a $477 million catastrophe bond for the United Services Automobile Assn.

But then again, it might not, says Brian Duperreault, chairman, president and chief executive officer of Hamilton, Bermuda-based ACE Ltd.

While the USAA deal showed that a large securitized layer of reinsurance coverage could be placed in the capital markets, it also showed that securitization still is more costly than conventional reinsurance coverage, he said. And other questions about the feasibility of securitization remain unanswered, Mr. Duperreault said at the International Insurance Society Inc. annual seminar held in Mexico City earlier this month.

ACE has run up against problems in its own efforts to securitize insurance risks. Last year it failed to place a bond that would have securitized $35 million in coverage.

The drive to securitize insurance risks was started due to the large number of catastrophes that have hit the insurance industry over the past 10 years, Mr. Duperreault said.

Insurers have suffered increasing strains on their capital as a result of the losses, he said.

"We don't want large fluctuations in earnings from a single event. We need protection from the spikes. Insurance pricing cannot respond to these spikes, so a logical place to look for protection is where the real money is: the capital markets," Mr. Duperreault said.

Several attempts to tap the capital markets have been tried in recent years with varying degrees of success, he said. These include the Chi-cago Board of Trade's catastrophe options, the CATEX catastrophe risk exchange, and various successful and aborted attempts at small bond placements.

The USAA placement was the first large-scale, successfully completed cat bond placement (BI, June 23). Since then, Swiss Reinsurance Co. has placed bonds related to California earthquake risk (see story, page 2).

The USAA placement made up part of an otherwise traditional reinsurance program. USAA probably could have placed the securitized portion of the program in the traditional market as well, and at a lower cost, Mr. Duperreault said.

But the placement may spark an interest in the capital markets in securitized insurance products, so USAA and other insurers may benefit by placing future bonds in a market more comfortable with the concept, he said.

"(USAA) spent money to do it, but they had their insureds' interests at heart," Mr. Duperreault said.

However, other obstacles still may need to be overcome before securitization really takes off, he said.

For example, many policyholders buy complex, customized insurance products that might not easily be covered under the current broad-brush coverage supplied through securitized insurance products, he said.

Also, the insurance companies that buy the securitized products may find that the accounting methods are more favorable for conventional insurance and reinsurance than they are for capital markets products, he said.

But these problems may be overcome, and capital markets-based insurance products may flourish, Mr. Duperreault said. "There's a lot going on below the surface of capital markets, and some of it may have substance. Maybe a number of structures will emerge," he said.