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
 Securitisation and
insurance derivatives

 Insuratisation

 Finite and financial reinsurance

 Captives
Examples of ART

Insurance Securitisation

 Transferring bundles of risk

directly to the capital markets
 CAT BOND

bond investors
bond
r/i policy

premium
cedant SPV
principal
claim

coupon
if the cat bond is
triggered, then
there is no return
of principal
 Cat bonds

Advantages: Disadvantages:

For cedant more capacity frictional costs

no credit risk traditional reinsurance
is cheaper

For bond high yield debt do they understand?

holder non-correlation
 Types of cat bond trigger
Parametric Modelled Loss Indemnity

Payouts based on Payouts based on Payouts based on

objective measurable modelled impact of actual losses incurred
variables parameters on pre-
identified
Structural representative
Features underlying portfolio

Minimal disclosure Substantive disclosure Greatest disclosure

about sponsor about sponsor about sponsor

Basis Risk Yes Reduced No

Data None required Detailed breakdown of High quality of

Requirements exposures within underlying data
selected portfolios necessary
Examples of ART
Insuratisation

 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

 Revenue guarantee

 Residual value

 Credit derivatives

 Enterprise risk
Insuratisation

Advantages: Disadvantages:

For insurer new line of business moral hazard

less competition correlation
not correlated unfamiliarity
with traditional book

For client new source of risk capital level of disclosure

competitive pricing how certain is
pay out?
Examples of ART

Finite

 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 4 5
YEARS
Examples of ART

Captives and protected cells

 Businesses bundle up their risks

before transfer to reinsurers or the
capital markets
ART at Lloyd’s

Why Lloyd’s should be strong

 Entrepreneurial culture

 Expertise in pricing basis risk

 Capacity to support the expertise

ART at Lloyd’s

Why Lloyd’s should be strong

 Direct access to decision makers

 Contingent capital market

 Strong licence network

ART at Lloyd’s

 Insuratisation: changes to financial

guarantee rules

 Securitisation and derivatives

 Finite
Financial guarantee at Lloyd’s

 Change to FG system for 2001

 Previously prohibited classes

now permitted

 Legal & regulatory limits

Securitisation at Lloyd’s

 RK Carvill and Lehman Brothers:

Lloyd’s syndicate receives
reinsurance protection in the
event of a US catastrophe

 ARTransform