The insurance-linked security industry appears to be evolving on two distinctly different fronts. On one hand, the 2004 and 2005 weather seasons tested the insurance and reinsurance industries' combined abilities to manage risks related to weather-induced catastrophes. These days, a much more benign period is testing its ability to find new business. Elsewhere, life and excess mortality risks are increasingly pushing the envelope for innovation in the industry.
What they have in common is that the capital markets are a key part of future growth, several securitization professionals said, especially when it comes to mining out new business.
"The bringing of new perils is absolutely critical for the growth of the market," Dan Ozizmir, a managing director of Swiss Re Capital Management and Advisory, said recently at a Securities Industry and Financial Markets Association (SIFMA) conference on insurance-linked securities. "The product development that everyone is speaking about is very critical," he said.
For securitizations that finance life and excess mortality risk, market professionals should rethink the notion that the collateral base has not grown quickly or fast enough, Ozizmir said. Examining the historic growth rate of the subsector, issuance of securities to fund life and excess mortality has seen a 40% compound growth rate.
"If you move that out 10 years, you'll see that the market is at $30 billion today, and [could be] hitting about $750 million in 10 years," Ozizmir said. The market can reasonably attain that level of activity, he said, considering that current Regulation XXX reserve requirements stand at around $100 million, a good portion of which could be securitized. Major perils, including Japanese and U.S. earthquake and U.S. wind risk, could potentially result in $100 billion in deals.
One such innovative deal to hit the insurance-linked securities market in 2006 was the $150 million Blue Wings transaction done by Alliance Re, which covered Canadian earthquake, U.S. earthquake risk outside California and U.K. flood risk.
The Blue Wings deal, a 144A transaction, was the first time that an explicit flood deal was separately modeled and structured, and transactions like that will continue, Ozizmir said.
Such large-scale catastrophe bond transactions as well as financings that stepped in after the 2004 and 2005 storm seasons tapped out insurance and reinsurance companies, said Rob Allard, a Deutsche Bank managing director who oversees the global alternative risk markets group. The capital markets, however, will have to begin looking at covering so-called high frequency, low-severity risks, such as motor insurance or trade credits. The latter mitigates risks to a company's commercial accounts, in case one of its buyers falls into insolvency or protracted default. This is especially true considering that the insurance and reinsurance industries are entering a relatively benign period of risk.
As transactions such as Scottish Re have gotten the market accustomed to financing reserve requirements under Regulation XXX, the capital markets are now turning their attention to more complex structures under AXXX.
The latter is more complex, because it finances risk for life insurance durations that average about 40 years, and which can stretch out to more than 70 years, said Cory Anger, a senior vice president at Lehman Brothers' insurance products group.
"How do you match the funding of the liabilities and make sure that the solution is going to be outstanding while the risk is outstanding?" Anger asked delegates, adding that one possibility would be, "taking from what we've done on the XXX side, and allowing [that] both the auction rate facilities and term ABS can be issued in the future."
Not deterred by the complexity of AXXX transactions and the long lead times they require for working out solutions before bringing them to market, Lehman Brothers expects a pipeline for the product, said Anger.
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