Rowan Douglas describes the way new media are changing the way risk is packaged, transferred and traded.
Reinsurance markets are created by the information and communication facilities available. Recent advances in these areas are so significant that they will have a profound impact on what we trade, where we trade it and, most significantly, with whom we trade. In response to these developments it is critical that reinsurers maintain their rightful location at the centre of any new environments and profit from the new products and distribution mechanisms that they afford.
Ironically, significant business discussions about risk, information, capital and communications are now possible because the main technical dilemmas seem over. The growth of the internet and world wide web, coupled with the development of related intranet and extranet facilities have curtailed years of debate upon future technology choices for reinsurance companies. On the eve of the millennium, few can doubt that opting against internet standards is tantamount to being unconnected within a connected world. Within our market even the diehards of previous initiatives have embraced this new order with enthusiasm.
The benefits for reinsurance boardrooms caught in increasingly competitive markets are clear. At long last information and business interests are in control of the IT agenda after years when the challenge of developing a technology strategy seemed to be an end in itself.
As the shackles of technical immaturity fall away, successful underwriters and brokers will increasingly correlate with those who are able to access, process and communicate risk information in new and more effective ways than their competitors.
Information creates the market
We base our understanding and evaluation of risks upon sources of information that represent those risks. Traditional sources of information dictated the type of policies used to provide agreed and accepted methods of selling options on other people's capital in the wake of misfortune. The communication environment has also influenced how we have operated.
Within the classic insurance environment of London in the 1600s, it was the provision of a meeting place, a simple, accepted register of losses and quill pens and parchment by Edward Lloyd that determined the type of policies available and how the market administered them.
Constraints within risk information and communication facilities over the last few hundred years have allowed us to enjoy a high degree of permanence in the operation and institutions within a market with few alternatives. The information and communication revolution threatens to change this picture abruptly because it will increase the options for describing, communicating and trading risk and widen the scope of who can play.
An early outcome of the networked world is that we will enjoy a plethora of information allowing us to broaden the range of contracts that we can create and increase the bounds of our market forever.
For example, picture 3 shows a real time image from the internet. It is a picture of the United States taken by a satellite updated every 12 hours. It splits up the US into its counties, and illustrates the amount of rainfall required in the next three hours to cause flooding in each county. It is available to anyone who wishes to view it via the web. It is a pretty map, but has little value for our existing market, beyond telling us where and when we are in trouble. For markets of the future though, the implications of this map may be profound.
Behind each one of these county squares is a number, an index of flood risk. A reinsurer could go to his prospective insurance client in the US and ask for his 40 counties of greatest flood exposure, these counties could be distributed throughout the US: some in New York, some in Texas, some in the Midwest and specific counties elsewhere, depending on the location of particular risks. By employing some historical analysis, it would be possible to show that when the aggregate number behind the 40 at-risk counties exceeded a defined figure, say 2,500, then the total loss for the insurance company's current portfolio would be approximately $30 million - a threshold that was reached, on average once every 10 years.
Upon the basis of this information, it would be possible to create a derivative-type contract that would trigger when the 2,500 level was breached for a defined period of time. A contract like this does not respond to everyone's requirements but it does exhibit a number of characteristics that may make it attractive.
* It can be bought at any time before the contract is breached. Of course the price may be high if the index is already at 2,250 but, nevertheless, a price could be created.
* Secondly, the basis of the index can be configured to closely match the characteristics of the insurer's portfolio. As the pool of risk related information grows, this ability to blend and customise indices to suit specific risk situations will grow and grow.
* A third benefit, and a key one, is that as soon as the 2,500 trigger is breached, funds can be transferred to the insurance company immediately. There is no need to go through a lengthy reinsurance claims administration process that can eat up so much of the premium. Indeed, because these information sources are electronic and accessible, it could be possible to embed them within administration systems to make the process almost automatic.
* A fourth benefit, though one with mixed effects for traditional reinsurers, is that the simplicity of these contracts will enable a wider range of capital providers to offer themselves for flood risk protection. Carriers could be reinsurers, but they could be other insurers, banks or even large industrial groups. Indeed we may find asset managers developing a portfolio of flood risk contracts as a hedge to traditional investments and see flood indices as a vehicle for speculation as much as risk transfer.
* Fifth, as a relatively simple contract, it may be more easily traded on the secondary market.
The principles may be extended to almost all classes of risk from tsunamis and bush fires to D&O liability. New information is already emerging that could support radically new responses to these risks.
Information and the development of alternative risk transfer
Ultimately, the growth in information products is likely to further stimulate the development of a functional and substantial alternative risk transfer market. One day, this may be less of an alternative risk transfer market and more of a single, unified risk transfer bourse where many contracts are traded to reflect the holistic needs of clients. Within this context, reinsurance will become one of many risk transfer options. Reinsurers are a key group among them, but they are not alone, as Marcel Polk of Citibank in London says: "There is not a big international investment bank that has not set up a unit to study reinsurance derivatives."
This market has been slow to develop for many reasons, but the fundamental one is that the information products have not emerged to allow banks and other capital providers to attach their products to these risks. As we have seen, the information to do this may be more accessible than we once thought.
From marketplace to marketspace
The development of a common digital standard coupled with the abundant information available in this environment will encourage many people to create electronic ways of communicating and trading risks. This is already beginning to occur with the early and successful development of CATEX, and the many client facing extranets such as Aon's Aonline, which has been in operation since March 1996 and which has been followed by others such as JH Marsh McLennan, Sedgwick Re, Benfield Grieg, CNA Re and many others.
In this way companies are beginning to attune themselves to the reality that deepening existing relationships, and increasing distribution of products will be achieved by competing for attention on the desktops of our markets. Reinsurers that do not seek to enter this marketspace will begin, slowly at first but increasingly in the future, effectively to reduce the attractiveness and availability of their products and services.
On a wider basis, various agencies may begin to convene information to create marketspaces via web media. Pictures 1 and 2 provide an illustration of what our markets may look like in the not-too-distant future and were built with the help of reinsurers and brokers in various markets to explore possible futures.
The first, Artemis Bermuda is a demonstration of an imaginary web based interface to the Bermuda reinsurance market designed for brokers in London, Paris and other European centres to access this capacity more easily. As the scope of Bermudian underwriting activity grew beyond traditional catastrophe lines, a need was recognised to communicate more effectively with producers of this business. The authorised brokers could view menus of risk transfer products and details of current capacity. It then provides supporting information on the personnel in this market, the financial security of underwriters and even the forthcoming travel plans of underwriters to European business centres.
A similar approach is illustrated by this second example which brings together all the websites of the world's leading property reinsurers into a single interface which allows brokers to see a global market at the same time for facultative, treaty and alternative transfer risks.
As screens such as these emerge, it becomes easier to recognised how these contexts will augment our traditional trading environments.
While the hegemony of the internet has eased our basic technology questions, its very success and commercial importance has raised the stakes of getting one's business strategy correctly directed for the digital domain. More than before, our networked world threatens to reshape and even redefine the reinsurance market in which we operate. Indeed it promises to create new, online, market landscapes which extend, or actually dissolve borders between our markets and others.
As the leading underwriters gather together here at the pinnacle of our existing market landscape, we must accept the challenge of becoming the architects of our own predominance in these new areas. To neglect our responsibilities in this area is to ignore the lessons of others and emulate other financial markets, such as LIFFE in London, that have failed to protect their position in new media and lost billions of pounds to competing markets in the space of a few short months.
Rowan Douglas is managing director, World-wide Intellectual Resources Exchange (WIRE) Limited. Tel: +44 (0) 1273 704414. Fax: +44 (0) 1273 704416. E-mail: email@example.com