Information about Alternative Risk Transfer

Alternative Risk Transfer (often referred to as ART) is the use of techniques other than traditional insurance and reinsurance to provide risk bearing entities with coverage or protection. The field of ART grew out of a series of insurance capacity crises in the 1970s through 1990s that drove purchasers of traditional coverage to seek more robust ways to buy protection.

Most of these techniques permit investors in the capital markets to take a more direct role in providing insurance and reinsurance protection, and as such the broad field of ART is said to be bringing about a Convergence of insurance and financial markets.

Key Areas of ART Activity

A major sector of ART activity is risk securitization including Catastrophe bonds and Reinsurance Sidecars.

Standardization and trading of risk in non-indemnity form is another area of ART and includes Industry Loss Warranties.

In addition, a number of approaches involve funding risk transfer, often within the structures of the traditional reinsurance market. Captive Insurance Companies are formed by firms and re/insurers to receive premiums that are generally held and invested as a "funded" layer of insurance for the parent company. Some captives purchase excess of loss reinsurance and offer coverage to third parties, sometimes to leverage their skills and sometimes for tax reasons. Financial reinsurance in various forms (finite, surplus relief, funded, etc.) consists of various approaches to reinsurance involving a very high level of prospective or retrospective premiums relative to the quantity of risk assumed. While such approaches involve "risk finance" as opposed to "risk transfer," they are still generally referred to under the heading of ART

ART is often used to refer to activities through which re/insurers transform risks from the capital markets into insurance or reinsurance form. Such transformation can occur through the policy itself, or through the use of a transformer reinsurer. This type of activity has been important in credit risk markets, hard asset value coverage and weather markets. Reinsurers were notable participants in the early development of the synthetic CDO and weather derivative markets through such activities.

A subset of activities in which reinsurers take capital markets risks is dual-trigger or multiple trigger contracts. Such contracts exist between a protection buyer and a protection seller, and require that two or more events take place before a payment from the latter tothe former is "triggered." For example, and oil company may desire protection against certain natural hazards, but may only need such protection if oil prices are low, in which case they would purchase a dual trigger derivative or re/insurance contract. There was a great deal of interest in such approaches in the late 1990's, and re/insurers worked to develop combined risk and enterprise risk insurance. Reliance Insurance extended this further and offered earnings insurance until the company suspended its own business operations. This area of ART activity diminished after the general hardening of the commercial insurance and reinsurance markets following the 9-11 terrorist attacks.

Another area of covergence is the emergence of pure insurance risk hedge funds such as Nephila, Fermat, Securis, Coriolis, Pentalia, Goldman Sachs Catastrophe Fund, Stark Catastrophe Fund, Acuance, Solidum, various Zurich-based funds managed by [Clariden Leu] Bank and Banque [AIG] and other such funds. These function economically like fully collaterallized reinsurers (and some of them operate through reinsurance vehicles, such as Nephila's Posiden Re and Goldman's Steamboat Re), but take the form of hedge funds. A more specialized version is Gamut Re, a tranched collaterallized risk obligation managed by Nephila.

Life insurance companies have developed a very extensive battery of ART approaches including Life Insurance Securitization, full recourse reserve funding, funded letters of credit, surplus relief reinsurance, administrative reinsurance and related approaches. Because life reinsurance is relatively more "financial" to begin with, there is less separation between the conventional and alternative risk transfer markets than in the property & casualty sector.

Emerging areas of alternative risk transfer include intellectual property insurance, automobile insurance securitization and life settlements.

Key market participants

Investment banks, notably Goldman Sachs, Lehman Brothers, Merrill Lynch and Citibank.

Insurers, including AIG, Zurich, and XL

Reinsurers, notably Munich Re, Hannover Re and Swiss Re both directly and through their capital markets subsidiaries.

Brokers including Willis, Marsh, Aon Corporation, Benfield, and Carvill.

Consultants, notably AIR, EQECat, Milliman International, Patterson Martin, Risk Management Solutions, Tillinghast and Watson Wyatt.

Key sectors

Key sectors of the Alternative Risk Transfer marketplace include the use of Captive Insurance companies, financial reinsurance, Finite Risk insurance, catastrophe bonds, Reinsurance Sidecars, contingent capital, captive insurers and reinsurers, dual trigger insurance, industry loss warranties, Weather derivatives

See also

• Captive Insurance Companies
• Reinsurance
• Catastrophe bonds
• Reinsurance Sidecars
• Financial reinsurance
• Finite Risk insurance
• contingent capital
• captive insurance
• Dual trigger insurance
• Industry Loss Warranties
• Life Insurance Securitization
• Weather derivatives
• Alternative risk financing
• Risk financing
• life settlements

Sources

For extensive coverage of this space see Reactions Magazine, Benfield Quarterly, Insurance Insider. The key reference work for the space is "Alternative Risk Strategies" published by Risk magazine 2002



Captive & ART Review [1]
A monthly publication dedicated to Alternative Risk Transfer for the business community

Alternative Risk Strategies, published by Risk Books and edited by Morton Lane is a comprehensive though dated guide to the entire area of Alternative Risk Transfer (Risk Waters, London, 2002)