Template AHG

1
The Alternative Market
A review of recent developments and the
implications for Insurers and Brokers David
Martin, Aon
2
Todays agenda

• What does alternative mean
• Some examples
• A review of the forces driving developments
• The implications for Insurers
• The implications for Brokers
• Conclusions on the opportunities

3
Alternative can mean any of the following

• Alternative Risks
• risks not traditionally insured in our market
• Alternative Products
• risk transfer products that are not insurance or
  reinsurance contracts
• Alternative Markets
• suppliers of risk capital that are not insurers
  or reinsurers
• In practice most deals are a combination of 2 or
  3 of the above

4
Example - Alternative Risks

• Insurance policy to protect BAe from a drop in
  lease income on 600 regional jet aircraft.
• 15-year program
• Insured limit 2.4bn
• Transaction cost 38m net of tax, mostly premium
• Indemnity for a Mass Transit project regarding
  future passenger levels?

5
Example - Alternative Product

• Catastrophe Bond for Oriental Land mitigating
  business interruption following an earthquake
  near Tokyo Disney
• Called Concentric Re
• Limit US 100,000,000
• 5 year period
• Priced around LIBOR 310 basis points ( 3.1
  rate on line)
• Pay out is not based on indemnity

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Not indemnity ?????????

• A Parametric trigger
• If the event happens client is paid, regardless
  of whether he has actually sustained a loss.
• The pay out is linked to the epicentre and
  magnitude of quake in three concentric rings (JMA
  scale)
• 6.5 inner circle,
• 7.1 inner ring,
• 7.6 outer ring

7
Example - Alternative Markets

• 4 year option on a bond to provide Allianz with
  new catastrophe cover against German windstorm
  and hail.
• Option may be exercised in the event of
  significant aggregate losses on existing
  portfolio.
• Limit US 150,000,000
• Price for subsequent coverage is predetermined
  (approx equivalent to 8 rate on line?)
• Risk is passed through a special purpose
  reinsurer (Gemini Re) to capital market investors
  in the bond.

8
Structure of Gemini Re deal
Prior to election of option
After election of option
Allianz
Allianz

If Allianz suffer aggregate losses
Reinsurance
Option
greater than a DM/Euro amount
Agreement
Agreement
equivalent to an expected loss of
5.85 (currently equal to DM380m)
they can elect to exercise the option
and obtain reinsurance cover from
Gemini Re
Gemini Re
Gemini Re.

Cover is for DM/Euro equivalent of
US150m excess of expected loss of
6.40 (currently equal to DM345m).

Gemini Re also enters into a

Gemini Re invokes Subscription
Subscription
Notes
Subscription Agreement with
Agreement requiring investors to
Agreement
Issuance
investors in the capital markets.
purchase an insurance linked Note.

Investors agree to subscribe to Notes

Investors collateralise Gemini Re
issued in the event Allianz exercises
with US150m to fund Reinsurance
the option.
Agreement.
Investors
Investors
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Driving forces - Corporate clients (1)

• Clients facing new risks from changes in
  technology, legislation, social attitudes and the
  global economy etc
• At the same time trends in corporate governance
  demand that they are able to demonstrate adequate
  risk management
• CEO/CFO views of risk
• anything that hurts our earnings per share or
  market capitalisation
• risk is risk (a loss is a loss)
• property/casualty exposures becoming relatively
  less importanteg Microsoft (June 1998
  figures)market capitalisation 500 bn
  approxproperty assets 1.5 bn approxcash
  liquid investments 13 bn

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Driving forces - Corporate clients (2)

• Demand coverage for new types of business risk
• Stand alone basis or integrated into a package
• Concern over the efficiency of insurance products
• indemnity agreement is usually highly conditional
  
• slow to respond (claims process)
• frictional costs too high (distribution and
  administration)
• global demand for traditional types of non life
  insurance has been flat for a decade

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Driving forces - Insurance Companies (as buyers)

• So far most capital market deals have protected
  insurers. Is this just tactical opportunism on
  their part?
• No - because each one takes a lot of time and
  effort to arrange and so far they have cost more
  than reinsurance equivalents anyway !
• Their incentive is to learn, and to access to new
  sources of secure risk capital at a known price
• Cat bond limits are fully collateralised with
  little credit risk
• Also, alternative programmes in general appear
  better for strategic capital, earnings and risk
  management
• ie the same things that interest corporate clients

12
Driving forces - Capital Markets

• There is lots of hungry capital in global savings
  markets
• looking for high yielding assets
• with little or no risk correlation with their
  regular portfolio of financial assets
• Insurance or event risk is of interest if there
  is
• Clarity in the trigger mechanism and no moral
  hazard
• Quality exposure data and objective risk
  assessment
• A formal investment rating (BBB or better)
• Liquidity (to sell out later if required)

13
Challenges for Insurers

• Excess capital is not limited to the insurance
  market
• So we will not see a hard market return just
  because a few reinsurers retire from the fray
• Are premium rates capped by the availability of
  capital markets?
• Broaden the scope of risks you can cover
• Look at new types of business risk or face being
  further marginalised by the clients
• Re-examine the flexibility and performance of
  your product
• Note the attraction of parametric triggers,
  options etc

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Challenges for Brokers

• Recognise the strengths of the new competition
• management consulting firms, investment banks etc
• Improve your understanding of client financial
  needs
• how good are you at probing, listening and
  financial interpretation?
• Upgrade your product and programme design skills
• demonstrate objectivity and credibility in
  comparing apples and oranges
• Get access and leverage in the new markets
• In short, stay relevant !

15
Opportunities for all of us

• Client demands for alternative risk management
  offer huge potential for the growth of our
  business
• Consulting opportunities
• Transactional (risk transfer) opportunities
• We can learn from and adopt the innovations in
  alternative products to make insurance more
  flexible and responsive
• options, trigger mechanisms etc
• We can use the capacity of alternative markets to
  improve the stability and pricing of our
  programmes
• Research and product development is the key to
  success

16
The Alternative Market
Any questions?
Slides available on the Insurance Institute of
Londons website www.iilondon.co.uk