Is it a case of ART for ART's sake, or will alternative methods of transferring and financing risk become an increasingly important tool? This issue of Global Reinsurance looks at the plethora of issues surrounding alternative risk transfer.
While the debate continues on what constitutes ART, there can be little doubt that the market is finally coming to terms with what the various products can offer. A recent survey by London-based law firm Denton Wilde Sapte discovered that financial guarantee has been the source of greatest demand, representing 52% of respondents to the most recent survey (conducted in 2000), compared to 13% the previous. One respondent commented: “Reinsurers are now approached daily from banks for credit enhancement products which are neither risk management or risk transfer products. They allow arbitrage between the cost of capital between insurers and banks.”
And survey respondents anticipated this trend would continue, with demand increasing from banks to swap credit risk with reinsurers, either in the form of straightforward financial guarantee, credit derivatives, collateralised debt obligations and corporate credit enhancement products such as credit wraps.
Regulatory arbitrage was perceived as the main driver to the change, while price differentials between credit business and re/insurance business is seen as being an important factor.
Surprisingly, diversification for re/insurers languished as a driver for change, although there is little doubt credit risk products do enhance portfolio mix.
As well as providing enhanced products for the banking sector, reinsurers are moving ever-closer to capital markets with product offerings which blend insurance and banking elements to provide innovative solutions. Prakash Shimpi, managing principal for Swiss Re New Markets in the US and one of the early practitioners in the ART arena, likens his organisation to an investment bank to the reinsurance industry, and his is not the only player in this field. By melding banking-style disciplines with reinsurance practices, new ways of dealing with old problems are adding value to the buyer.
For example, Bermuda headquartered Max Re has been able to take over old life books, using the expertise of asset manager and major Max Re investor Moore Capital to help reduce the pricing. Luc Gagnon, managing director of Max Re's Dublin office, explains in this issue how the Max Re model – the ‘Max Frontier' as he terms it –- manages portfolios on both the life and non-life side.
Towards the end of last year, speculation abounded that ART products would see a higher take-up going forward, particularly as traditional reinsurance capacity became more expensive in a hardening market. Lehman Brothers expects catastrophe bond issuance to double over the course of 2001, reaching $2bn by year-end. This, it argues, is the result of the 1999 industry losses and the withdrawal of high quality retrocession capacity.
So far, the problem with cat bonds has been lack of diversity; US East Coast windstorm, West Coast quake and Japanese quake have dominated offerings, but this too is changing. On the one hand, more detailed cat models have enhanced pricing on these issues. On the other, issues are becoming more diversified; Mediterranean Re's offering uses French windstorm and Monaco quake as risks. In addition, the number and range of subscribers has increased dramatically from the handful of specialists in the mid- to late-1990s to the full gamut of money managers, re/insurers and banks. As the market enlarges and matures in this way, again the question of what constitutes alternative risk transfer raises its head.
Unusual and entrepreneurial risks are also lending themselves to the ART market. One respondent to Denton Wilde Sapte's research noted, “Recent deals include intellectual property, asset returns, amusement park receipts, internet business cover, real estate lease enhancement, student loans, internet sales for business-to-business exchanges, motor warranty refunds, executive liability, auto residual value.” An impressive list, indeed. While product launch failure is an entrepreneurial risk the vast majority of respondents felt rated high on the ART demand scale, more than half saw price fluctuation smoothing as a way forward. In fact, the 1998 British Aerospace transaction did just this, ring-fencing liabilities from long-term aircraft leasing deals – improving the organisation's share price as a result.
So far, the ART experience has been pretty good, and it is attracting more players to its table. Bermuda – often the hub of the new ‘new thing', according to Ross Webber of the Bermuda International Business Association – is now marketing itself as the ‘convergence island', citing its strong financial services sector and e-commerce capabilities as a complete package for ART-type deals. Whether the location of e-commerce organisations has any particular impact is uncertain. What is sure, however, is that technology, whether in the preparation of detailed models for possible cat losses or as potential trading platforms, undoubtedly will play an ever-increasing role in the ART – and traditional – world.