Alternative risk transfer mechanisms against the background of

Alternative risk transfer mechanisms against the background of the Austrian legal framework – a suggestion for improvement Mag. Monika Gruber o. Univ. -Prof. Dr. Matthias Bank Department of Banking and Finance, Leopold-Franzens Universität Innsbruck, Austria in collaboration with: alp. S Gmb. H – Centre for natural hazard management, and Hypo Tirol Bank AG, Austria SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Alternative Risk Transfer (ART) ART & ARF • Risk transfer & Risk financing (self-insurance & risk retention) • Insurance & Capital markets (convergence) • Alternative because traditional financial products are applied to insurance issues, or vice versa • Supplement to traditional insurance • Standardisation and individualisation (tailoring) • Multi-year, Multi-line, Multi-trigger • Participation in positive loss experience • Main field of application: natural catastrophes, liability, terrorism SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Alternative Risk Transfer (ART) ART & ARF Risk Finance ( ARF): Risk Transfer ( ART): Funded Retention, Risk Finance (ARF) & Self-insurance, Risk Transfer in its Provision of funds “ex ante“ Unfunded Post-loss Financing Risk Transfer ibs proper meaning (ipm) Retention Risk Transfer ipm Risks are retained in the company: Risks are transferred to another corporate entity: DEDUCTIBLE & FINANCE TRANSFER Funded Pre-loss Financing Risk Finance • Self-insurance • Captives • Contingent Capital • Finite Risk Solutions • Traditional Insurance • Securitisation: Bonds & Insurance. Derivatives • Insuritisation • Integrated Risk Management SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Reasons for ART & ARF • Un-insurable risks: natural hazard, terrorism risk, technological risks • Relatively high frequency and intensity of natural and technical catastrophes, climate change • High population density, e. g. Tirol (Austria) 445 inh. /km 2 (2004) High-quality building materials additional insurance cover needed • Insurance industry provides no/limited cover for certain risks • Lack of insurance (capacity, supply, demand) • Responsibility of the government? e. g. catastrophe funds, monopolistic/compulsory insurance Reasons for ART Need for alternative solutions … SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Reasons for ART - Austria ART & ARF Reasons for Limited Coverage for Property insurance against natural hazards: ART Basler, Generali, GRAWE, Niederösterreichische, Zürich, Donau Versicherung, VAV € 5. 000 oder 7. 500 Allianz, UNIQA, Wiener Städtische, Merkur, Salzburger Landes. V Up to 50% of the insured sum [IS] Tiroler Versicherung Plus H. E. L. P. Alpin € 75. 000 € 150. 000 (IS < € 360. 000) (IS > € 360. 000) Business Insurance: Business interrruption, fire, theft, storm and certain natural hazards, liability, property etc. Combined business policies Additional catastrophe cover up to € 150. 000 per event !! Cumulation Clause: If the insurer‘s total claims exceed max. € 30 Mio. , the damage compensations will be paid aliquotly. SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Reasons for ART & ARF Why is there a lack of insurance? Reasons for ART Difficult and expensive risk simulations necessary for proper insurance of low frequency – high severity risks Consequently premium calculation problematic High cost of reinsurance of certain risks Low demand for cover against natural hazards (? ): “A once-in-a-hundred-years event is expected to occur once in a hundred years. So, why insure after the occurrence of such event? ” No capacity on the (Re-)Insurance market SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Reasons for ART & ARF … Why is there a lack of insurance? Reasons for ART Reinsurers’ interest: limited supply of cover higher premium, less risky portfolio higher equity returns shareholder value maximisation Agency issues, moral hazard, adverse selection Governmental Intervention – public funds e. g. Austrian Catastrophe Fund with approx. € 250 -400 Mio. annual compensation capacity (already insufficient after flood 2002 and 2005) e. g. Austrian Terror Pool – conjoint damage compensation through Austrian insurance companies up to € 200 Mio. , no state guarantee SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

ART mechanisms ART & ARF Reasons for Risk Transfer & Risk Financing ART Traditional Insurance Market Financial Reinsurance ART & ARF mechanisms Carriers Instruments Self-insurance Multi-year, Multi-line, Multi-trigger Products Risk Retention Groups, Insurance Pooling Finite Risk (Re-)Insurance Captive Insurance Companies Securitization (ILS, Bonds, Insurance derivatives) Capital Markets Weather derivatives Contingent Capital SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

The Austrian Legal Background (I) ART & ARF Insurance Market Regulations Reasons for ART – EU-Directives Solvency I+II: ART mechanisms Legal Background solvency margins, capitalisation, capital structure, etc. – EU-Directives on European Reinsurance and Insurance Broking: capitalisation of captives, regulation of fronting, etc. – International Financial Reporting Standards: differences particularly regarding the accounting treatment of financial instruments, etc. SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

The Austrian Legal Background (II) ART & ARF Reasons for Taxation and Accounting Issues ART – Insurance Tax (§ 1 Vers. St. G) ART mechanisms Legal Background captives, RRGs – Corporate Income Tax (§ 26 BAO, § 18/1 Z 2 ESt. G) financial and insurance derivatives, deductibility of insurance premiums (captives, finite risk reinsurance) US-IRS statements – Capital Gains Tax (KESt) derivatives, weather derivatives, cat bonds, finite risk (re-)insurance, contingent capital, captives – Regulations concerning accounting practices (öHGB, IFRS) e. g. capital reserves and provisions all ART instruments SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

The Austrian Legal Background (III) ART & ARF Reasons for Insurance Market Surveillance (e. g. VAG) ART mechanisms – Requirements for the establishment of insurance companies in Austria (e. g. capital stock) captives, RRGs, pooling arrangements Legal Background – General insurance terms and conditions (AVB) finite risk (re-)insurance, insurance derivatives, captives, etc. – Insurance contract law (VVG) finite risk (re-)insurance, insurance derivatives, captives, etc. SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

The Austrian Legal Background (IV) ART & ARF Reasons for Additional Legal Issues ART mechanisms Legal Background – Public funds and support in case of catastrophes (Kat. Fondsgesetz 1996, Tir Kat. Hilfsdienstgesetz) – Regional planning, hazard zone planning (GZPVO, TROG, Forst. G, TBO) – Proposal for a Directive of the European Parliament and the Council on the assessment and the management of floods 2006 HORA: information system regarding property risk profiles, generalized basis for insurance pricing in Austria , already established as part of the future implementation of the mentioned Directive SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Critical Issues – ART implementation ART & ARF Reasons for ART • Premium deductibility to be clarified by (inter)national jurisdiction ART mechanisms Legal Background Implementation Issues • Additional provisions for insurance and capital market surveillance on national, European and international level • Harmonisation of market regulations in order to increase transparency and enhance fair pricing on insurance and capital markets e. g. capitalisation, solvency margins, reporting requirements and standards SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Critical Issues – ART implementation ART & ARF Reasons for ART • Public-Private Partnership for more efficient risk sharing and risk reduction ART mechanisms Legal Background Implementation Issues • Assessment of critical market volumes and target groups in Austria, in particular concerning captive formation and individualised contracts as e. g. weather derivatives • Creation of a risk reducing culture including improved risk perception – improving individual risk responsibility SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana

Thank you! For additional information please contact Monika. Gruber@uibk. ac. at SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? 11 -13 September Ljubljana