banking, insurance and reinsurance: the market for risk transfer

Karlsruhe, 11 December 2002, Dirk Lohmann

Banking, Insurance and Reinsurance: The Market for Risk Transfer

Banking, Insurance and Reinsurance:The Market for Risk Transfer

© Converium

December 11, 2002Important Disclaimer

Although all reasonable care has been taken to ensure the facts stated herein are accurate and that the opinions contained herein are fair and reasonable, this document is selective in nature and is intended to provide an introduction to, and overview of, the business of Converium. Where any information and statistics are quoted from any external source, such information or statistics should not be interpreted as having been adopted or endorsed by Converium as being accurate.

Neither Converium nor any of its directors, officers, employees and advisors nor any other person shall have any liability whatsoever for loss howsoever arising, directly or indirectly, from any use of this presentation.

This document contains forward looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995. It contains forward looking statements and information relating to the Company's financial condition, results of operations, business, strategy and plans, based on currently available information. These statements are often, but not always, made through the use of words or phrases such as 'expects', 'should continue', 'believes', 'anticipates', 'estimated' and 'intends'. The specific forward looking statements cover, among other matters, the improving reinsurance market, the expected losses related to the 11 September attack on the United States, the outcome of insurance regulatory reviews, the Company's operating results, the rating environment and the prospect for improving results and unaudited reports on premium volume developments. Such statements are inherently subject to certain risks and uncertainties. Actual future results and trends could differ materially from those set forth in such statements due to various factors. Such factors include general economic conditions, including in particular economic conditions; the frequency, severity and development of insured loss events arising out of catastrophes; as well as man made disasters such as the 11 September attack on the United States; the ability to exclude and to reinsure the risk of loss from terrorism; fluctuations in interest rates; returns on and fluctuations in the value of fixed income investments, equity investments and properties; fluctuations in foreign currency exchange rates; rating agency actions; changes in laws and regulations and general competitive factors, and other risks and uncertainties, including those detailed in the Company's filings with the U.S. Securities and Exchange Commission and the Swiss Exchange. The Company does not assume any obligation to update any forward looking statements, whether as a result of new information, future events or otherwise.


© Converium

December 11, 2002

Key differences across sectors highlighted by recent BIS report(*)

How sectors pass on risks to secondary markets

Financial consolidation benefits – a re-evaluation

Risk transfer trends in the (re)insurance industry

Talking points

(*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“, Cross-sectoral comparison, November 2001


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December 11, 2002Talking points





If time allows: Consolidation of multiple risks



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December 11, 2002Risk management across sectors

Insurance Companies Commercial Banks Security Firms

Primary Risks Technical risk (liability risk) & Investment risk (asset risk)

Credit risks & funding liquidity risk

Market risk & liquidity risk

Typical Time Horizon

Long-term (often multiple years)

Medium-term (usually one year)

Short-term (often 1 to 10 days)

Risk Measurement

Quantitative (actuarial) techniques to calculate size of necessary technical provisions

Risk limiting and sharing via deductibles, reinsurance & ART

Asset and Liability management

Quantitative models calculate economic capital necessary to absorb unexpected credit loss at target confidence level

Asset and Liability management

Value-at-risk and stress testing methodologies for market & liquidity risk

Credit risk minimized through collateral and master netting agreements

Provisions / reserves vs. Capital

Technical provisions as estimate of foreseeable claims while capital covers unexpected losses

Provisions much higher than Capital

Loan loss reserves to cover expected losses and capital to cover unanticipated losses

Capital usually higher than Reserves

Holding capital rather than reserves because valuation on a mark-to-market basis

Capital much higher than Reserves

Large differences in primary risks, typical time horizon and level of capital vs. provisions/reserves


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December 11, 2002Supervision across sectors

Insurance Companies Commercial Banks Security Firms

Capital regulation / solvency regime frameworks

(1) Risk-Based-Capital (USA, Canada, Japan and others)

(2) Index based solvency regime (EU and others)

Basel Accord (1) Net Capital approach (USA, Canada, Japan, and others)

(2) EU Capital Adequacy Directive, based on Basel Accord Amendment for market risks

Overall concern

Soundness of individual insurers, not just system as a whole

Stability of system as a whole rather than preserving individual banks

Accounting conventions

Variety of different approaches Historical cost approach Marked-to-market

B/S Focus Liability side of balance sheet Asset side of balance sheet

Ratio actual vs. required capital

Actual capital often several times minimum required level

Usually hold no more than 150% of their capital requirement

Capital frameworks

Different definitions of eligible capital, charges applied to individual risks, aggregation methodologies of these charges, and scope of application of framework (to individual firms, groups of firms or consolidated groups)

Supervision differs significantly by sector and regions


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December 11, 2002





Talking points



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December 11, 2002

Security firms: Passing on risk to capital markets

Security firms usually pass on risk of financial securities immediately to secondary markets rather than holding them on to their own balance sheet

Bor

row

er/

Issu

e r

Secondary

Markets

PlacementPackaging


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December 11, 2002

Banking: Separation of origination and management

Banks have started to separate origination and management of their loan portfolios

Portfolio management optimises the bank’s balance sheet by passing on “undesired” risks to secondary markets

Bor

row

e rs

Portfolio Management

Client Mgmt / Origination

Secondary

Markets

Syndication

Loan Trading

Securisation

Credit Derivatives


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December 11, 2002Insurance: Traditional reinsurance & ART

Difficulties in packaging insurance risks for secondary markets: Lack of homogeneity hinders risk standardisation (basis risk) Moral hazard makes assessment of inherent risk difficult for secondary market Opaqueness of underlying risks can best be mitigated through personal

relationships (trust & continuity)

Insu

red

ReinsuranceCompaniesInsurance

Companies

Reinsurance

ARTSecondary

Markets


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December 11, 2002





Talking points



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December 11, 2002

“One-Stop Global Financial Shopping” –A paradigm of the 1990’s

The mid- to end 1990’s witnessed broad-based horizontal and vertical integration of financial institutions

There was no dominant pattern for horizontal integration. We saw: Banks acquiring insurers Insurers acquiring banks Insurers and Banks acquiring asset managers Reinsurers venturing into project finance and direct insurance Reinsurers offering third-party asset management

Glass-Steagall Act repeal of 1999 gave additional fuel to expectations about financial consolidation


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December 11, 2002

Reassessing the costs and benefits of integration in the financial services industry

Perceived Benefits in the 90’s

Materialized costs and problems of today

Creation of synergies Integration of controls, processes, legacy systems, incentive schemes and culture

Opportunities for cross-selling Customers like their freedom to choose: they like specialists, they like spreading the risk, they like keeping all their options open

Scale efficiencies Economies of scale are not unlimited

Regulatory arbitrage Regulators and rating agencies are becoming faster at closing the gaps


© Converium

December 11, 2002

“One Stop Global Financial Shopping” –A management fad of the 1990’s?

Glass Steagall repeal has not sparked a wave of consolidation and integration of financial institutions

Recent news highlight a return to financial services de-consolidation:

Citibank spinning off Travelers Property Casualty business CS attributing losses to Winterthur Allianz attributing losses to Dresdner Bank ZFS selling Scudder, spinning off its reinsurance division and

announcing a “strategy of greater focus” on core insurance-based products


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December 11, 2002





Talking points



© Converium

December 11, 2002

Transferee Incentive for risk acceptance:

Attractive underlying risk-return trade off Consistency with overall business

strategies Good understanding of risk Perceived diversification benefits No legal/regulatory barriers Low regulatory capital charge No severe accounting/tax implications

The logic behind cross-sectoral risk transfers

Transferors Transfer risks that they take on as

a part or a consequence of their core business activities

Incentive for risk transfer: Cost of transferring or hedging the risk lower than cost of retaining the risk on balance sheet

Transferor(Sector A)

Transferee(Sector B)


© Converium

December 11, 2002The traditional risk transfer avenues

Capital Markets

Insurance Risks

CapitalMarket Risks

(Re)Insurance Markets

Insurance /

Reinsurance

Investment /Hedging


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December 11, 2002

Are there feasible diagonal (ART) risk transfer avenues?

Capital Markets

Insurance Risks

CapitalMarket Risks


?


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December 11, 2002

One possible direction for ART - Securitization

Capital Markets

Insurance Risks

CapitalMarket Risks


“Securitization” (i.e. CAT risk, upfront expenses) Insurance linked securities

(CatEPut, Surplus Notes)Securitization, CAT bonds, etc.


© Converium

December 11, 2002

Another Direction of ART - “Insuritization”A path littered with failures

Capital Markets

Insurance Risks

CapitalMarket Risks


“Insuritization”

(i.e. credit and credit derivatives risks, asset performance risk, business risk, etc.)

Collateralized bond obligations Residual value transactions Credit enhancement transactions Film Financing


© Converium

December 11, 2002

Why did (re)insurers go into the wrong direction?

Lack of profitability in their traditional reinsurance risk transfer business

Slow growth rates in mature non-life reinsurance markets, coupled with a perceived need for top-line growth

Perception of much higher expected ROE’s being earned in the structured finance businesses:

ROE’s shown in banking industry had been misleading through aggressive leveraging practices now exposed in the last 12 months (off-balance-sheet SPV’s)

Systemic risk underestimated by re-/insurers and overlooked dependence to own asset side risk


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December 11, 2002What’s happening now?

Some of the “new” risks written in the late 90’ are coming home to roost – losses are emerging

Recent events such as losses associated with Enron have led to greater reluctance to entertain this business – reputation or explanation risk

Financial markets volatility beyond what managers expected – more risk present than perceived

Problems from the core business are setting the agenda of management

Heightened regulatory, rating agency and corporate governance focus leading to greater disclosure and managerial discipline

banking, insurance and reinsurance: the market for risk transfer

Documents

forward looking statements

risk of loss

improving reinsurance

risk transferkarlsruhe

reinsurance indu

available information

results of operations

business of converium