ART for reinsurance does work

The International Association of Insurance Supervisors’ (IAIS) Developments in (Re)Insurance Securitisation report says that the alternative risk transfer models used, although relatively small, have worked.

But it warned:

• Securitisation arrangements tested by the current financial crisis showed important weaknesses, from excessive reliance on a key party to the arrangement (ie the Total Return Swap counterparty) to problems with the arrangement’s investments (eg lack of transparency). Importantly, the crisis highlighted the inherent complexity of insurance securitisation arrangements.
• Basis risk, especially that inherent in arrangements using non-parametric triggers, remains a key concern for regulators, as to date there have been almost no cases in which this type of securitisation was tested in practice.

The reports conclusions include:

• The market for cross-sectoral transfer of insurance risk into capital markets has experienced growth over the past decade. Although it is still relatively small when compared to traditional reinsurance there is evidence that the upward trend is likely to continue, generating more volume of business and eroding market share to traditional reinsurance, especially in relation to new capital.
• Cross-sectoral risk transfer appears to be benefiting the insurance and reinsurance markets. By generating additional capacity, it has exercised some, although modest, counter-cyclical effects as well as contributing to more competitive markets.
• There is some degree of incompatibility between the long-tail nature of the liabilities and the desire for short term certainty from investors as more often than not the ceding company and the special purpose insurer reside in different jurisdictions, effective and timely cooperation among supervisors appears critical.

The IAIS said work on regulating the sector was ongoing.