Alternative Risk Transfer27 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

bo

nd

investo

rs

principal

coupon

bond

claim

r/i policy

CAT BOND

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

premium SPVcedant

Cat bonds

For cedant more capacity frictional costs

no credit risk traditional reinsuranceis cheaper

For bond high yield debt do they understand?

holder non-correlation

Advantages: Disadvantages:

Types of cat bond triggerParametric Modelled Loss Indemnity

Payouts based onobjective measurablevariables

Payouts based onmodelled impact ofparameters on pre-identifiedrepresentativeunderlying portfolio

Payouts based onactual losses incurred

StructuralFeatures

Minimal disclosureabout sponsor

Substantive disclosureabout sponsor

Greatest disclosureabout sponsor

Basis Risk Yes Reduced No

DataRequirements

None required Detailed breakdown ofexposures withinselected portfolios

High quality ofunderlying datanecessary

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

For insurer new line of business moral hazard

less competition correlation

not correlated unfamiliaritywith traditional book

For client new source of risk capital level of disclosure

competitive pricing how certain ispay out?

Advantages: Disadvantages:

Examples of ART

Finite

Usually multi-year contracts in which the loss experience and time value of money is explicit.

Examples of ARTFinite

YEARS

LOSS

RATIO

(%)

1 5432

200200

100100

5050

150150

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