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Karlsruhe, 11 December 2002, Dirk Lohmann Banking, Insurance and Reinsurance: The Market for Risk Transfer.

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Presentation on theme: "Karlsruhe, 11 December 2002, Dirk Lohmann Banking, Insurance and Reinsurance: The Market for Risk Transfer."— Presentation transcript:

1 Karlsruhe, 11 December 2002, Dirk Lohmann Banking, Insurance and Reinsurance: The Market for Risk Transfer

2 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 1 Important 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.

3 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 2 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

4 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 3 Talking 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

5 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 4 Risk management across sectors Insurance CompaniesCommercial BanksSecurity 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

6 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 5 Supervision across sectors Insurance CompaniesCommercial BanksSecurity 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 approachesHistorical cost approachMarked-to-market B/S FocusLiability side of balance sheetAsset 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

7 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 6 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

8 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 7 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

9 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 8 Banking: Separation of origination and management Banks have started to separate origination and management of their loan portfolios Portfolio management optimises the banks balance sheet by passing on undesired risks to secondary markets Borrowers Portfolio Management Client Mgmt / Origination Secondary Markets Syndication Loan Trading Securisation Credit Derivatives

10 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 9 Insurance: 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)

11 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 10 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

12 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 11 One-Stop Global Financial Shopping – A paradigm of the 1990s The mid- to end 1990s 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

13 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 12 Reassessing the costs and benefits of integration in the financial services industry Perceived Benefits in the 90s 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 efficienciesEconomies of scale are not unlimited Regulatory arbitrageRegulators and rating agencies are becoming faster at closing the gaps

14 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 13 One Stop Global Financial Shopping – A management fad of the 1990s? 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

15 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 14 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

16 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 15 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)

17 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 16 The traditional risk transfer avenues Capital Markets Insurance Risks Capital Market Risks (Re)Insurance Markets Insurance / Reinsurance Investment / Hedging

18 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 17 Are there feasible diagonal (ART) risk transfer avenues? Capital Markets Insurance Risks Capital Market Risks (Re)Insurance Markets ?

19 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 18 One possible direction for ART - Securitization Capital Markets Insurance Risks Capital Market Risks (Re)Insurance Markets Securitization (i.e. CAT risk, upfront expenses) Insurance linked securities (CatEPut, Surplus Notes) Securitization, CAT bonds, etc.

20 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 19 Another Direction of ART - Insuritization A path littered with failures Capital Markets Insurance Risks Capital Market 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

21 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 20 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 ROEs being earned in the structured finance businesses: ROEs shown in banking industry had been misleading through aggressive leveraging practices now exposed in the last 12 months (off-balance-sheet SPVs) Systemic risk underestimated by re-/insurers and overlooked dependence to own asset side risk

22 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 21 Whats 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

23 Banking, Insurance and Reinsurance: The Market for Risk Transfer © Converium December 11, 2002 Page 22


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