MONTE CARLO, Monaco-In a reinsurance market flush with capacity, interest remains high in using capital markets to finance risk.

Reinsurance executives say, however, that the level of interest exceeds the number and size of financial deals actually being done on the insurance side.

What's driving interest in capital market financing is the possibility of inadequate capacity in the market for a serious catastrophic event, though there has not yet been a catastrophe of a size to prove that theorem, noted Steven J. Bensinger, president of Chartwell Re Corp. of Stamford, Conn.

"The market lulls itself into a false sense of capacity," he said.

"There's more insured values worldwide, including development throughout the third world, not just in the U.S.," Mr. Bensinger said. "What's the U.S. industry's capitalization? $250 billion? You can have a $100 billion loss event, according to the cat models," he said.

There's a lot of interest in catastrophe bonds, though activity has been modest, said David Jarvis, global head of financial institutions for Salomon Brothers Inc. in New York.

Contrary to some fears, Mr. Jarvis said, the securitization of risk and other capital market innovations will not threaten traditional reinsurers. The savings and loan or building society does not disappear because mortgages are securitized, he noted.

In addition, the expertise of the reinsurer still is needed to price a cat bond, he added.

Capital markets products will likely find a place in the marketplace, but they still are evolving, said James Duffy, president of St. Paul Re in New York.

"It's slow taking off, and the products are specialized, but in the long run they will have a bearing on the marketplace," he said.

Late last year, St. Paul set up a special purpose vehicle called Georgetown Re, which is backed by capital markets investors. Georgetown Re enables St. Paul to increase its capacity for short-term property risks.

The facility allows reinsurance buyers to increase their capacity through the purchase of more reinsurance from a highly rated reinsurer rather than seeking additional reinsurance from less well-rated reinsurers, Mr. Duffy said.

Guy Carpenter & Co. Inc. took a lead in the research of capital markets products more than two years ago, but the products have not yet taken off, said Brandon Sweitzer, president and chief executive officer.

While the demand for capital markets products so far has been limited, the groundwork for future success now is in place, he said.

Guy Carpenter, for example, has established a catastrophe index that the newly established Bermuda Catastrophe Exchange will use.

"The index has to be seen to work. People have to realize that it is transparent, and they have to learn to include it in their language. That will take a bit of time," said Hady Wakefield, chairman of Guy Carpenter.

The success of a few capital markets products shows that the investment market is beginning to open up to the products, said Dirk Lohmann, chief executive officer of Zurich Re, a unit of Zurich Insurance Co. in Zurich, Switzerland.

Mr. Lohmann was involved in the development of capital markets products at his previous employer, Hannover Re Group.

"There is a greater comfort with the concept," he said.

Zurich Re will seek to develop some capital markets products for clients seeking alternative capacity, Mr. Lohmann said.

A market for catastrophe bonds will take some years to develop, "because investors aren't used to this type of risk yet," said Bruno Porro, a member of the executive board of Swiss Reinsurance Co. of Zurich. "With a choice between a junk bond and a cat bond, they'll likely choose the junk bond," he said.

Nevertheless, the Swiss reinsurer recently made its first foray into transferring catastrophic risk to the capital markets with a bond deal tied to its purchase of $112.2 million in California earthquake reinsurance coverage (BI, July 28).

For now, the friction costs are high in the capital markets, said one U.S. reinsurance executive who asked not to be identified. Even so, he suggested that capital markets eventually may have the most success in financing high-layer catastrophe risks.

He estimated insurers worldwide retain about $5 billion for catastrophe risks. Above that, reinsurers are providing capacity for losses in the $5 billion to $20 billion range.

"Capital markets can try to compete in that five-to-20 band, or go for the market excess of $20 billion," he said. "They'll have a hard time competing with the price and expertise from traditional reinsurers in the five-to-20 band, but above that, it's hard to say," the executive said.

There is little need now for capital markets capacity to supplement traditional reinsurance capacity, said Serge Osouf, president and chief operating officer of SCOR S.A. in Paris.

"There is enough capacity in the market to cover the market's needs. To be able to offer the kinds of returns that investors in the capital markets products are looking for, you need a very hard market," he said.

Also, capital markets products are much more expensive to offer than traditional reinsurance, Mr. Osouf said.

"You need investment bankers, lawyers, you need to redraft the agreement every year and conduct your due diligence," he said.

While traditional reinsurers need to conduct similar work, reinsurance is well-established, and it is an efficient market, Mr. Osouf said.

But for now there has been more talk than action, said James Dowd, chairman and chief executive officer of Odyssey Reinsurance Corp. in New York.

"With the amount of capacity available in the marketplace at the moment, there is not much need for securitized coverage. . .it will have its place, but it might take five years," he said.

In addition to providing added protection in the event of a large catastrophe, capital markets risk financing may also help prevent a rapid and dramatic hardening of the market after a loss, one analyst said.

"On the property reinsurance side, the securitization of the risk will have an impact in not permitting the kind of pricing after Andrew and Northridge," said Donald S. Watson, director of reinsurance ratings for Standard & Poor's Corp. in New York.

That benefit justifies the high expenses of the reinsurers currently trying to develop these capital market tools, he said.