Hugh Rosenbaum describes Dublin as a “primordial financial soup” where new forms of integrated risk financing could evolve.
The last decade of the last century of this millennium has seen a sudden, even explosive evolution of new forms of insurance and risk financing. Like any other organisms in a challenging and varied environment, risk financing techniques have developed in fascinating and unpredicted ways, giving rise to some unrecognisable forms. But there are still blank areas on the map of integrated risk financing where no new techniques have evolved yet.
Tillinghast-Tower Perrin's decision to organise a conference in Dublin (15-16 March 1999) on the merging of the insurance and financal risk sectors was strongly influenced by our belief that Dublin could well be the place where the next breakthrough in risk financing occurs. The conference is all about exploring the applications of new techniques and identifying where new ideas will come from and the forms that will actually work.
Attention is focusing on financing large but infrequent risks and others which have previously been deemed “uninsurable”. Combining them represents the new field of opportunity. For example, software piracy could result in a major loss of income from loss or impairment of intellectual property or brand name rights. Regulatory reversals or an unexpected negative outcome from a promising venture might lead to a major loss of value. Smaller, more frequent risks are by definition more insurable, although there are exceptions; no one has yet offered insurance against a hangover, as far as I know.
Risk managers, treasurers and corporate finance executives are looking for ways of financing their large and rare risks, insurable or uninsurable, for both accounting and operation reasons. Ideally, they would like to transfer these risks to others entirely, but in the absence of willing risk takers, they seek other ways of financing them. This boils down to funding - either pre-loss or post-loss.
The current toolkit available to those who need to finance risks runs the gamut from pre-loss to post-loss finance:
• Traditional insurance
• Finite insurance/financing.
• Insurance options and forward contracts.
• Contingent capital options.
• Asset backed capital mobilisation arrangements.
• Cat bonds.
• Loan-as-insurance, or insurance as credit.
None of these techniques is ideal by itself. The first two techniques are available in Dublin and well established, while others, although potentially more available, are more difficult to detect. Securitisation of risk and trading of risk through swap deals has so far been limited mainly to natural catastrophe for insurance and reinsurance companies. They could be extended to direct financing of corporate risks as well.
Capital financing is unlikely to replace risk financing as the way forward. The reward to risk capital, as Brian O'Hara, president and ceo of Bermuda's Exel, keeps reminding us, has to be in excess of 15%. The rate on line of risk taking insurance can be as low as 0.1%. Because of this kind of disparity, simply asking investors to compete with insurers by taking insurable risks will not go very far. What will make it more attractive to both sides is the development of new and different expressions or baskets of risks that can be subject to a combination of financing and insurance.
Loans as insurance present an accounting problem - how to show the total liability in the books - and finite insurance encounters similar accounting issues in the United States and United Kingdom, although less so in France and Germany.
The ideal solution, and the next new form of risk financing, lies somewhere on the spectrum between pre-loss and post-loss finance. The question for every company or organisation is: what is the optimum point? A major problem is that what may make sense operationally may not be feasible in accounting terms and vice versa.
A suitable environment
Given that not all these techniques are widely practised in Dublin, why is the breakthrough to new forms of risk finance likely to happen there? The answer comes down to one word: environment.
The development of Dublin as a financial frontier, spurred by tax breaks offered by the International Financial Services Centre (IFSC) has brought together treasury functions, investor services, buyers of risk finance services, insurance service providers and professional infrastructure. To that you add the right balance of regulation, tax treaties, tax environment and Ireland being part of the euro-zone. Low moral hazard provides security.
This has created the right conditions, a kind of primordial financial soup, from which new risk financing - and advanced risk financing - can and ought to arise.While these conditions are necessary, they are not in themselves sufficient. A spark is needed, a stimulus to create the new form of risk financing. That spark is likely to come from a major international organisation, commercial or an international finance insti-tution like the World Bank, which does the next big deal or the first of several big deals.
What kind of big deal? I see it as a combination of credit and insurance, credit as insurance, a mix of pre-loss and post-loss finance and of insurable and uninsurable, such as my previous example of protection against a major loss of income resulting from loss or impairment of intellectual property or brand name rights caused by software piracy.
Whatever the new technique, it will have to be (seen to be) credible, which will require transparent quantification, objective triggers, security of adjudication and above all, minimal moral hazard.
It will not be easy to put such deals together. After all, they have not happened yet. Dublin may need to call on its reserves of the famous fighting spirit, not to mention luck. But it will happen, if only because the prize is too attractive for it not to.
Hugh Rosenbaum is a principal in the London office of Tillinghast Towers-Perrin. Tel: +44 (0) 171 379 4411; fax: +44 (0) 171 379 7478.