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Prepared for Cover magazine – February 2012 issue
The ART of converting capital market capacity
to insurance capacity
Traditionally, capital and insurance markets have each stuck to their own
‘space’; but, thanks largely to the ongoing woes that have plagued the world’s
financial markets in recent years and the resulting low interest rates, these
two sectors now find themselves converging, speaking the same language
and working together far more than in the past.
Capital markets are inherently more cash flush than insurers and reinsurers,
so the latter are, understandably, more conservative. Especially in the first
world, capital markets’ Holy Grail has always been higher returns but, in the
current financial climate, these are extremely hard to realise, so capital
markets are looking elsewhere to deliver those returns. Enter emerging
markets, where capital providers are willing to operate in a more risky
environment in order to secure good returns. Yes, the risk is higher but, with
the potential to boost returns by up to ten times that of first world markets,
capital markets are developing an appetite for emerging market insurance
risk.
Of course, it’s not quite as simple as that: the capital first needs to be
transformed into insurance capital and this is where alternative risk transfer
(ART) comes into play. In a nutshell: the ART structure facilitates the most
effective use of capital, providing insurance cover and laying the risk off to the
capital market through some form of alternative structure, rather than
conventional reinsurance. Such structures – which, until now, have been
relatively rarely used in South Africa – can, if used properly, provide
significant capacity.
When the insurance market is in a hard market cycle, or there is no appetite
for a particular risk in the conventional market, ART facilities can play a pivotal
role in providing cover by converting capital risk into insurance risk. This is
also true of the current soft, but selective, insurance market, where insurers
are writing primarily for price, even though there is capital available.
Using their ART facility to convert capital market capacity into insurance
capacity effectively allows corporates to enhance their facility’s capacity and,
at the same time, secure the exact cover they need, at the best possible price.
The concept of converting capital risk to insurance risk is not new: reinsurers
have been doing it for years. What is new is taking it into the ART
environment, where facility owners are able to access capital markets directly,
allowing them to tailor make cover according to their very specific needs.
Using ART to convert capital market capacity to insurance capacity has other
benefits too: providers of capital are protected against taking excessive risks
in areas where they have less expertise in terms of management and pricing
of risks; and financial companies are able to hedge risks that did not exist
before.
In recent times, the lines between different financial markets have blurred
considerably. Banks are shifting credit risks from their balance sheets to
insurance companies; and insurance companies are issuing catastrophe
bonds that are being sold to institutional investors such as investment funds
and other capital investors.
And, through it all, ART continues to play an important role: helping to
facilitate more manageable credit and insurance cycles and even smoothing
premium curves, leading to lower cyclicality among financial companies’
earnings.
ENDS
For further information please contact:
Herman Schoeman, MD of Guardrisk
Telephone: 011 669-1001
Issued by:
Melanie Davis, PR@Work
Telephone: 011 615-3309 / 083 225 7450