SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Alternative risk transfer mechanisms against the background of the Austrian legal framework – a suggestion for improvement Mag. Monika Gruber o.Univ.-Prof. Dr. Matthias Bank Department of Banking and Finance, Leopold-Franzens Universität Innsbruck, Austria in collaboration with: alpS GmbH – Centre for natural hazard management, and Hypo Tirol Bank AG, Austria

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Alternative Risk Transfer (ART) Risk transfer & Risk financing (self-insurance & risk retention) Insurance & Capital markets (convergence) Alternative because traditional financial products are applied to insurance issues, or vice versa Supplement to traditional insurance Standardisation and individualisation (tailoring) Multi-year, Multi-line, Multi-trigger Participation in positive loss experience Main field of application: natural catastrophes, liability, terrorism ART & ARF

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Alternative Risk Transfer (ART) Risk Finance (  ARF): Funded Retention, Self-insurance, Provision of funds “ex ante“ Risk Transfer (  ART): Risk Finance (ARF) & Risk Transfer in its proper meaning (ipm) ART & ARF Retention Risks are retained in the company: DEDUCTIBLE & FINANCE Risk Transfer ipm Risks are transferred to another corporate entity: TRANSFER Unfunded Post-loss Financing Funded Pre-loss Financing Risk Finance Self-insurance Captives Contingent Capital Finite Risk Solutions Risk Transfer ibs Traditional Insurance Securitisation: Bonds & InsuranceDerivatives Insuritisation Integrated Risk Management

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Reasons for ART Un-insurable risks: natural hazard, terrorism risk, technological risks Relatively high frequency and intensity of natural and technical catastrophes, climate change High population density, e.g. Tirol (Austria) 445 inh./km 2 (2004) High-quality building materials  additional insurance cover needed Insurance industry provides no/limited cover for certain risks Lack of insurance (capacity, supply, demand) Responsibility of the government? e.g. catastrophe funds, monopolistic/compulsory insurance  Need for alternative solutions … ART & ARF Reasons for ART

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Reasons for ART - Austria Limited Coverage for Property insurance against natural hazards : Basler, Generali, GRAWE, Niederösterreichische, Zürich, Donau Versicherung, VAV € oder Allianz, UNIQA, Wiener Städtische, Merkur, Salzburger LandesV Up to 50% of the insured sum [IS] Tiroler Versicherung - Plus H.E.L.P. Alpin € (IS < € ) € (IS > € ) Business Insurance: Business interrruption, fire, theft, storm and certain natural hazards, liability, property etc. Combined business policies Additional catastrophe cover up to € per event !! Cumulation Clause: If the insurer‘s total claims exceed max. € 30 Mio., the damage compensations will be paid aliquotly. ART & ARF Reasons for ART

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Reasons for ART ART & ARF Reasons for ART Why is there a lack of insurance? Difficult and expensive risk simulations necessary for proper insurance of low frequency – high severity risks Consequently premium calculation problematic High cost of reinsurance of certain risks Low demand for cover against natural hazards (?): “A once-in-a-hundred-years event is expected to occur once in a hundred years. So, why insure after the occurrence of such event?” No capacity on the (Re-)Insurance market

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Reasons for ART ART & ARF Reasons for ART … Why is there a lack of insurance? Reinsurers’ interest: limited supply of cover  higher premium, less risky portfolio  higher equity returns  shareholder value maximisation Agency issues, moral hazard, adverse selection Governmental Intervention – public funds e.g. Austrian Catastrophe Fund with approx. € Mio. annual compensation capacity (already insufficient after flood 2002 and 2005) e.g. Austrian Terror Pool – conjoint damage compensation through Austrian insurance companies up to € 200 Mio., no state guarantee

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana ART mechanisms ART & ARF Reasons for ART ART mechanisms

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana The Austrian Legal Background (I) Insurance Market Regulations –EU-Directives Solvency I+II: solvency margins, capitalisation, capital structure, etc. –EU-Directives on European Reinsurance and Insurance Broking: capitalisation of captives, regulation of fronting, etc. –International Financial Reporting Standards: differences particularly regarding the accounting treatment of financial instruments, etc. ART & ARF Reasons for ART ART mechanisms Legal Background

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana The Austrian Legal Background (II) Taxation and Accounting Issues –Insurance Tax (§1 VersStG) captives, RRGs –Corporate Income Tax (§ 26 BAO, § 18/1 Z 2 EStG) financial and insurance derivatives, deductibility of insurance premiums (captives, finite risk reinsurance)  US-IRS statements –Capital Gains Tax (KESt) derivatives, weather derivatives, cat bonds, finite risk (re-)insurance, contingent capital, captives –Regulations concerning accounting practices (öHGB, IFRS) e.g. capital reserves and provisions all ART instruments ART & ARF Reasons for ART ART mechanisms Legal Background

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Insurance Market Surveillance (e.g. VAG) –Requirements for the establishment of insurance companies in Austria (e.g. capital stock) captives, RRGs, pooling arrangements –General insurance terms and conditions (AVB) finite risk (re-)insurance, insurance derivatives, captives, etc. –Insurance contract law (VVG) finite risk (re-)insurance, insurance derivatives, captives, etc. The Austrian Legal Background (III) ART & ARF Reasons for ART ART mechanisms Legal Background

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Additional Legal Issues –Public funds and support in case of catastrophes (KatFondsgesetz 1996, Tir KatHilfsdienstgesetz) –Regional planning, hazard zone planning (GZP- VO, TROG, ForstG, TBO) –Proposal for a Directive of the European Parliament and the Council on the assessment and the management of floods 2006  HORA: information system regarding property risk profiles, generalized basis for insurance pricing in Austria, already established as part of the future implementation of the mentioned Directive The Austrian Legal Background (IV) ART & ARF Reasons for ART ART mechanisms Legal Background

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Premium deductibility to be clarified by (inter)national jurisdiction Additional provisions for insurance and capital market surveillance on national, European and international level Harmonisation of market regulations in order to increase transparency and enhance fair pricing on insurance and capital markets e.g. capitalisation, solvency margins, reporting requirements and standards Critical Issues – ART implementation ART & ARF Reasons for ART ART mechanisms Legal Background Implementation Issues

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Critical Issues – ART implementation Public-Private Partnership for more efficient risk sharing and risk reduction Assessment of critical market volumes and target groups in Austria, in particular concerning captive formation and individualised contracts as e.g. weather derivatives Creation of a risk reducing culture including improved risk perception – improving individual risk responsibility ART & ARF Reasons for ART ART mechanisms Legal Background Implementation Issues

SRA-E 2006 Conference - Innovation and Technical Progress: Benefit without risk? September Ljubljana Thank you! For additional information please contact