Alternative Risk Transfer 27 October 2000 Peter Allen

Alternative Risk Transfer 27 October 2000 Peter Allen Head of Alternative Risk Transfer Lloyd’s

What is ART? ART is an umbrella term for a range of products, other than conventional annual insurance or reinsurance, which handle financial risk. Generally, these products import techniques, attitudes and language from corporate finance and the capital markets into areas normally dominated by insurers, or vice versa.

Examples of ART n Securitisation and insurance derivatives n Insuratisation n Finite and financial reinsurance n Captives

Examples of ART Insurance Securitisation n Transferring bundles of risk directly to the capital markets

CAT BOND r/i policy cedant premium SPV principal claim coupon if the cat bond is triggered, then there is no return of principal bond investors bond

Cat bonds Advantages: Disadvantages: more capacity frictional costs no credit risk traditional reinsurance is cheaper For bond high yield debt do they understand? holder non-correlation For cedant

Types of cat bond trigger

Examples of ART Insuratisation n n Using insurance capital and skills to price and assume banking risk Expands the insurable universe of risk towards the inclusion of any surprise which can impact corporate earnings

Examples of insuratisation n Revenue guarantee n Residual value n Credit derivatives n Enterprise risk

Insuratisation Advantages: For insurer For client Disadvantages: new line of business moral hazard less competition correlation not correlated with traditional book unfamiliarity new source of risk capital level of disclosure competitive pricing how certain is pay out?

Examples of ART Finite n Usually multi-year contracts in which the loss experience and time value of money is explicit.

Examples of ART Finite 200 150 LOSS RATIO 100 (%) 50 1 2 3 YEARS 4 5

Examples of ART Captives and protected cells n Businesses bundle up their risks before transfer to reinsurers or the capital markets

ART at Lloyd’s Why Lloyd’s should be strong n Entrepreneurial culture n Expertise in pricing basis risk n Capacity to support the expertise

ART at Lloyd’s Why Lloyd’s should be strong n Direct access to decision makers n Contingent capital market n Strong licence network

ART at Lloyd’s n Insuratisation: changes to financial guarantee rules n Securitisation and derivatives n Finite

Financial guarantee at Lloyd’s n n n Change to FG system for 2001 Previously prohibited classes now permitted Legal & regulatory limits

Securitisation at Lloyd’s n n RK Carvill and Lehman Brothers: Lloyd’s syndicate receives reinsurance protection in the event of a US catastrophe ARTransform