INDUSTRY INCREASINGLY EMBRACES SECURITIZATION

MONTE CARLO, Monaco -- The reinsurance industry appears to accept that risk securitization is here to stay, and several reinsurers are moving to capitalize on the new tools.

The use of capital market instruments is a natural complement to reinsurance, some executives say.

Even so, several reinsurance executives attending the Rendez-Vous de Septembre earlier this month point out that the viability and staying power of capital markets instruments has yet to be tested by a significant loss.

"The idea of the moment is convergence of capital markets and reinsurance," said Donald S. Watson, director of reinsurance ratings for Standard & Poor's Corp. in New York.

"There's a lot of interest in the capital markets, but volume won't be significant enough to drive growth for a number of years," he said.

"It's a big investment to make at a time when premiums are down for the reinsurance industry," he added.

Given the high cost of entry, banks getting into insurance securitization may have an edge over reinsurers, Mr. Watson said. That's because they already have a great deal of expertise in structuring financial deals, resulting in lower expenses compared with reinsurers that have to acquire this expertise, he explained.

Bermuda has become a center for capital markets products because of its reinsurance and financial expertise, Mr. Watson said, pointing to the activity to date there. Capital markets start-ups in Bermuda this year, he noted, include Arrow Reinsurance Co. Ltd., formed by Goldman Sachs, and Lehman Re Ltd., formed by Lehman Brothers.

Commercial Risk Partners Ltd., a Bermuda-based subsidiary of SCOR S.A., announced at the Rendez-Vous the formation of a new operating division called Commercial Risk Capital Markets that will focus on opportunities in the convergence of insurance and capital markets. The company will recruit a team of specialists, to be based in Bermuda, during the fourth quarter.

"This sector of the market is growing rapidly in importance, and our involvement is a natural evolution of our business as a provider of non-traditional capacity to the market," said Graham C. Pewter, president and chief executive officer of Commercial Risk Partners in a statement.

Currently, capital markets-based reinsurance products cannot beat traditional reinsurers on price, said Jacques Blondeau, chairman and CEO of SCOR.

"But each of them is a prototype," he said.

Once securitization methods have been formalized, capital markets-based products will be able to compete better with traditional reinsurance, especially if prices rise after a future catastrophe, Mr. Blondeau said.

And securitized products will likely hold back the ability of reinsurers to drastically increase catastrophe reinsurance prices in the same way they did after Hurricane Andrew, he said.

Rather than increasing rates on line after a big loss to more than 30%, reinsurers may increase those rates only to 15% to 20%, to keep prices competitive with catastrophe bonds, Mr. Blondeau said.

And if interest rates remain low, the securitized reinsurance products will be very attractive to investors, he said.

SCOR is far from alone in seeking to tap the capital markets.

Zurich Re will be in the risk securitization business, and it is looking to complete an offering for its first deal by the year's end, said Dirk Lohmann, CEO of Zurich Insurance Co.'s reinsurance division. Another securitization idea already is in the wings for 1999, he added.

Brian Murphy, who previously headed up Guy Carpenter & Co. Inc.'s securitization efforts, was hired to coordinate a securitization strategy for all Zurich entities, Mr. Lohmann said.

In the deals under consideration, Zurich Re will act as a portfolio manager and place risks from its portfolio with the capital markets, Mr. Lohmann explained. The company is looking to eventually use capital markets tools for also financing third-party risks, he added.

One reinsurer that has already been involved in capital markets deals is Swiss Re New Markets, a unit of Swiss Reinsurance Co. in Zurich.

The increase in the number of companies being set up to offer the products is a reaction to the marketplace, said CEO Erwin Zimmerman.

"The change is on the demand side," he said.

More cedents and corporations are realizing that securitized products can provide solutions to problems that are not met by conventional reinsurance, he said.

For example, if a company is looking for long-term catastrophe coverage, it may find it more attractive to set up a capital markets deal than to try to seal the coverage with a reinsurer, Mr. Zimmerman said.

"It can be expensive. But if you get it right, it can be a very effective technique," he said.

The deals are particularly attractive to companies based in the United States that have to worry about investor scrutiny every quarter and wish to reduce their exposure to volatility, Mr. Zimmerman said.

Currently, most capital markets deals cover catastrophe exposures. But in the future, an increasing number will more likely cover bulk risks such as life insurance, auto insurance and credit risks, he said.

Homogeneous risks can be bundled together and derivatives can be sold in the same way as mortgage-backed securities, he said.

And while securitization will change the wholesale sector of the insurance and reinsurance market, it should not radically change the retail sector, Mr. Zimmerman said.

"Risks will still come in through the primary reinsurers," he said.

Hannover Reinsurance A.G., a pioneer in the risk securitization arena, has completed three such deals and will continue to be active in this area, said Hans D. Rohlf, managing director and chief underwriting officer-North America for the Hannover, Germany-based reinsurer.

The first two Hannover Re securitization deals involved property catastrophe exposures, while the third deal involved a portfolio of life/health exposures.

The essence of reinsurance is to provide a spread of risk, and investors could use risk securitization offerings in the same way, Mr. Rohlf said.

SOREMA S.A. is setting up a new alternative risk transfer department to explore such deals.

"SOREMA is one of the first reinsurers of its size to do this," observed Alexis Ruset, chairman and CEO of the Paris-based reinsurer. "We have to invest in the future to meet the need of our ceding companies."

Securitization will definitely be part of the future, said James Dowd, chairman and CEO of Odyssey Reinsurance Corp. in New York.

And although several investment banks have established units to develop capital markets-based reinsurance products, reinsurers will not be pushed out, he said.

"All of us will be involved on some level or other. . . .The key is understanding the transaction and the underlying business," he said.

CNA Financial Corp.'s acquisition of Hedge Financial in 1997 gives CNA Re a "laboratory to experiment in securitization and take some basis risk," said William J. Adamson, CEO of the Chicago-based reinsurer.

Currently, though, there remain some issues to be worked out before securitization takes off, he said. These include accounting issues and how deals should be optimally structured.

Once such issues are resolved, capital markets instruments could help risk-bearing entities to assume additional risk to meet clients' demands, Mr. Adamson said. Securitization deals "may be able to help in those cases, eliminating the downside of risks assumed," he said.

"Right now, we haven't found the new wave of securitization to be less expensive than the traditional way of doing reinsurance," observed Steven J. Bensinger, president of Chartwell Re Corp. in Stamford, Conn.

"The big question is the staying power of these markets," said Michael A. Butt, a director of X.L. Mid Ocean Reinsurance Co. Ltd. of Hamilton, Bermuda.

What will happen when the first cat bond blows up?

"Some traditionalists think that will make capital markets go away, but nobody takes a really big position in those," so a loss is unlikely to drive away investors, said Mr. Lohmann of Zurich Re. "These investors are sophisticated and not blind to the risk, even if it is different from junk bonds," he said.