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transcript
Karlsruhe, 11 December 2002, Dirk Lohmann
Banking, Insurance and Reinsurance: The Market for Risk Transfer
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© 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.
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© 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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© Converium
December 11, 2002Talking points
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
If time allows: Consolidation of multiple risks
(*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“, Cross-sectoral comparison, November 2001
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© Converium
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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© Converium
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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© 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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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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
Bo
r ro
we
r/
Iss u
er
Se
conda
ry
Ma
rkets
PlacementPackaging
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© Converium
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)
Ins u
r ed
Reinsurance
CompaniesInsurance
Companies
Reinsurance
ARTSecondary
Markets
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© 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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© Converium
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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© 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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© 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)
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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© Converium
December 11, 2002The traditional risk transfer avenues
Capital Markets
Insurance Risks
CapitalMarket Risks
(Re)Insurance Markets
Insurance /
Reinsurance
Investment /Hedging
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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December 11, 2002
Are there feasible diagonal (ART) risk transfer avenues?
Capital Markets
Insurance Risks
CapitalMarket Risks
(Re)Insurance Markets
?
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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December 11, 2002
One possible direction for ART - Securitization
Capital Markets
Insurance Risks
CapitalMarket Risks
(Re)Insurance Markets
“Securitization” (i.e. CAT risk, upfront expenses)
Insurance linked securities (CatEPut, Surplus Notes)
Securitization, CAT bonds, etc.
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December 11, 2002
Another Direction of ART - “Insuritization”A path littered with failures
Capital Markets
Insurance Risks
CapitalMarket Risks
(Re)Insurance Markets
“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
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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
Banking, Insurance and Reinsurance:The Market for Risk Transfer
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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
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© Converium
December 11, 2002