| Financial innovations can open the US insurance market to wider disaster coverage
"Historically, insurance has been an essential part of stability and recovery for individuals, businesses and communities - encouraging recovery, economic growth and prosperity," said Glenn Yago, director of capital studies at the Milken Institute. "We need to rethink how we approach catastrophic risk and private-public partnerships in this field so that communities have the resources necessary to recover quickly in the event of a disaster." The report, ‘Financial Innovations for Catastrophe Risk: Cat Bonds and Beyond,’ is based on a Milken Institute Financial Innovations Lab attended by representatives from the insurance, reinsurance, and bond ratings industries, along with practitioners in finance, law and government regulation. This Financial Innovations Lab and the report were supported by Allstate Insurance Company. "Expanding the investor pool for insurance-linked securities will help diversify investor portfolios at attractive returns," said Jeff Cooper, assistant vice president of protection finance for Allstate Insurance Company. "If we can do this and streamline the transactions for insurers, sovereign entities and other risk bearers, this market will have a tremendous positive impact on disaster recovery." Catastrophe bonds - also known as cat bonds - and other insurance-linked securities are alternative sources of capital for insurers, reinsurers, governments and companies that can provide both capacity and price stability. Governments and industry have started to look at these innovations. In 2005, the Mexican government became the first federal sponsor to issue a catastrophe bond, Cat Mex, for protection against major earthquake losses. These new tools are gaining a foothold in the marketplace. For example, the cat bond market grew from $2 billion in 2002 to $14 billion in September 2007. These bonds outperformed equally rated corporate bonds in the period from January 2005 through September 2007, returning 25.65 percent versus 17.51 percent. However, they face regulatory, industry-based and market barriers, such as high transaction fees and an insufficient supply of issuances, before they can make the necessary impact. The report offers several solutions to ease these barriers: - Decrease fees and standardize transactions through a variety of measures that include eliminating the need to conduct transactions offshore by establishing special purpose vehicles (SPVs) onshore and by standardizing loss warranty documents, issuance structuring and documentation. - Attract large institutional investors by increasing the amount of investment-grade cat bond issuances. - Securitize a wider range of risk (currently the majority of bonds are for wind and earthquake risk) and geographic distribution (including fast-developing regions, such as India and China) to increase diversity in the market. - Educate investors and, more important, asset allocators, to enhance legitimacy and further establish the bonds as an asset class. - Improve risk management tools for investment professionals, develop - Increase liquidity and transparency in the secondary market by issuing larger transactions. - Increase participation by the rating agencies to achieve more than a single rating, currently the norm, to attract more traditional fixed-income investors.
•Date: 1st May 2008• Region: US •Type: Article •Topic: Operational risk
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