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CHICAGO-Risk securitization will supplement-not replace-traditional reinsurance, according to a panel of top industry insiders.
Given the inevitability of the capital markets' role in risk transfer and the advantages risk securitization can offer, however, it's not a subject insurance executives can afford to overlook.
Underscoring the widely held view of risk securitization's inevitability was the inability to bring a contrarian perspective to the 7th Annual Insurance Executive Forum sponsored by the Katie Insurance School of Illinois State University in Normal.
"Believe it or not, we really couldn't find a panelist to take that contrarian point of view," according to Donna Galer, executive vp of Zurich-American Insurance Group in Schaumburg, Ill.
Ms. Galer moderated the Oct. 14 event in Chicago, which was titled, "Securitization of Insurance Risks: Myths and Realities."
"I think if it had been a year or a year-and-a-half ago, we'd have been sitting here saying, 'Except in a few very isolated instances this has been all talk and no action,' " said Scott A. Levine, president and CEO of Zurich Centre ReSource in New York.
Now, there are some significant examples of risk securitization, Mr. Levine said. He cited catastrophe bond deals this year by United Services Automobile Assn. and Swiss Reinsurance Co. "as probably the two most seminal deals that have been done."
Meanwhile, Richard L. Sandor, chairman of Hedge Financial Products Inc. in Chicago, pointed to Warren Buffett's decision to provide $1.5 billion in conventional reinsurance to the California Earthquake Authority last year as the most significant event to date for its role in changing investor perspectives.
"I think that was something that traders and investors all of a sudden said, 'Well, if Warren Buffett thinks it's a great deal, why don't I?' " Mr. Sandor said.
Kevin R. Callahan, president and CEO of Aon Capital Markets Inc. in Chicago, noted that while the capital markets might not be more economical than traditional reinsurance at the moment, they do offer access to capital, the prospect of lower-priced capital in the future, and flexibility.
Flexibility, he suggested, is the key.
"I think the issuers that have utilized these markets to date have had very different objectives," he said. "And these transactions have been structured to meet those objectives."
In addition to flexibility, the vast capacity of the capital markets is another factor driving the move, particularly when coupled with such economic changes as increased property values in high-risk areas, panelists noted.
Also, in an industry where rates are being squeezed, the opportunity to do a 10-year deal in the capital markets for 100 basis points as opposed to paying a broker 1,000 basis points every year "has not gone unnoticed," Mr. Sandor said, citing the opportunity risk securitization provides to reduce frictional costs.
"In terms of change, what's happened, I think, financial engineering has made the change from equity to fixed-income type instruments more affordable for people who were purchasing that capacity," said Andrew J. Kaiser, a vp at Goldman Sachs & Co. in New York who heads the investment bank's insurance product group.
And from an investor perspective, catastrophe bonds and other risk securities are proving attractive, offering them the yield, performance and portfolio diversification they seek, Mr. Kaiser said.
Jonathan E. Michael, president and chief operating officer of Peoria, Ill.-based RLI and Mount Hawley Insurance Cos. and executive vp of RLI Corp., discussed his company's experience in 1996 securing an extra layer of reinsurance coverage through a catastrophe equity put, or CatEPut.
"We were looking for a cost effective way to put something on top of (RLI's existing reinsurance) program," Mr. Michael said. "Our Aon broker brought Aon Capital Markets into the equation."
The CatEPut will provide RLI with standby capital in the event of a California earthquake through a deal in which Centre Reinsurance Co. of New York agrees to purchase $50 million in preferred securities from RLI, which RLI would ultimately repurchase.
"Compared to traditional reinsurance, it was very affordable," Mr. Michael said. "Three- to four-year payback on a security is not unreasonable, and it was a real good rate."
"If (an earthquake) were to have happened, we would have owned a security that we had full confidence would be a good security," said Mr. Levine of Zurich Centre ReSource.
"From our point of view, it gave us additional diversity from some of the normal cat business that we were in," he said.
From a reinsurer's perspective, Mr. Levine said he sees the capital markets as "the repository for taking generic, uncomplicated risk cheaply long-term."
"As a reinsurer. . .we want to solve our clients' problems," Mr. Levine said, noting the reinsurer wants those problems to be "complicated, ugly," adding, "I want to get very well-paid for serving our client."
But, after solving those problems, he'd prefer to take the simpler portion of those risks and pass them to the capital markets.
"The markets don't want to take ugliness," Mr. Levine said. "The markets are really good at the straightforward, simple, big risks."
That approach leads to what Mr. Sandor suggests could be a model for the 21st Century, in which all of an insurer's liability risks should be looked at as dynamic, with the entire book of business available to the capital markets every day for a price.
"Now that's very common in the mortgage market," Mr. Sandor said. "This may be the same sort of thing in years to come."
While the panelists noted that those attending the forum need to examine capital markets opportunities, particularly with an eye toward helping customers hedge their companies' entire exposure to risk and protect shareholder value, Mr. Levine noted that it's important to find appropriate opportunities.
"I think the worst thing that anybody can do is walk out of here and say, 'I've got to do a securitization today,' " he said. "The game is not finding solutions in search of problems. The game here is serving clients' needs."
In addition to the Katie School, Business Insurance, Zurich-American Insurance Group, KPMG Peat Marwick L.L.P., Kemper Insurance Cos. and CNA Insurance Cos. co-sponsored the forum.