Insurance, Finance, Solvency II and Financial Market Interaction
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Insurance, Finance, Solvency II and Financial Market Interaction Michael Butt AXIS Capital Holdings Ltd, Chesney House, 1st Floor, 96 Pitts Bay Road, Pembroke HM 06, Bermuda. E-mails: [email protected], [email protected]
The convergence and interplay between the insurance sector and the capital markets is likely to increase as will the diversity of products the capital markets offer. The speed and depth of this increase will depend on the ability of the insurance sector to improve its data quality and its risk management practices, and the number and size of large losses in the next several years as the markets develop their knowledge. Ultimately, those insurers who have the best data collection and control will have a competitive edge in leveraging their own risk management franchises for stakeholders. The Geneva Papers (2007) 32, 42–45. doi:10.1057/palgrave.gpp.2510115 Keywords: capital markets; Solvency II; sidecar; risk management; enterprise risk
In the post-Katrina debate, convergence of insurance markets with the broader capital markets, as well as the evolution of risk management practices and assessment of these practices critical to supporting this convergence, have taken center stage. The credibility factor has become very relevant with respect to evaluation of managements as good stewards of capital in our industry. In the face of credibility issues around management teams following insurance companies’ recent performance, particularly during the 2005 hurricane season, capital providers have sought, and continue to seek out, ways to invest in discrete opportunities. In the most extreme cases, they are participating in opportunities mimicking transparent ‘‘bets on the weather’’. This reality, coupled with the purest market forces, will strengthen and advance discipline around the measurement, management and communication of enterprise risk. Since the 2005 hurricane season, the industry has faced substantially increased capital requirements. This is only partly driven by the increased frequency and severity of expected losses. The more dramatic impact has come from increased rating agency capital requirements per unit of exposure. As in previous market dislocations, incumbents looked to the capital markets to shore up balance sheets, new reinsurance companies were formed, largely in Bermuda, and catastrophe bond activity increased. It would appear that many commercial lines insurers and reinsurers have considered, and continue to consider, a range of options for the transfer of catastrophic risk to the capital markets, with particular emphasis on those alternatives that replicate the indemnity-based characteristics of traditional reinsurance providers. Ratings downgrades and market withdrawals post Katrina only highlight recoverable credit risk following a major cat event. Unique to this market dislocation is the advent of the ‘‘sidecar’’ to address investor demand for transfer of catastrophe risk, in particular. The sidecar concept is described in more detail later. Increased rating agency
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