Operating & Financial Review

2006 market overview

Alternative risk transfer

Since Hurricane Katrina there has been a re-emergence and growth of alternative risk transfer (“ART”) products. These non-traditional, capital markets driven products include catastrophe bonds and swaps, industry loss warranties (“ILWs”), contingent capital and most recently the creation of sidecars. Although all slightly different in nature their principal aim is to transfer risk from cedants, either to tradeable capital markets securities or to short-term, special purpose vehicles collateralised with capital often provided by hedge funds and private equity investors.

Approximately $8.6 billion was invested in ART products in 2006, up approximately 140% on 2005. ILWs are estimated to have provided an alternative for 20% of the retrocessional reinsurance market in 2006, compared to only 5% prior to hurricane Katrina.

Recent hurricane seasons
1950-2006
average
2004
2005
2006
2004-2006
average
Named storms
11
15
28
9
17.3
Hurricanes
6
9
14
5
9.3
Cat 3-5*
2
6
7
2
5.0
Cat 5*
0.4
1
4
0
1.7
US Hurricanes**
1.5
6
5
0
3.7
US Cat 3-5*
0.6
3
4
0
1.3
Insured Loss
$7Bn
$24Bn
$55Bn+
$0Bn
$26Bn
* Cat 3-5 refers to the strength of hurricanes according to the Saffir-Simpson scale
** Refers only to those hurricanes which made landfall in the United States.
Source: Risk Management Solutions

Although these figures are small when compared to the size of the global non-life insurance market, they have provided much needed capacity at a time of scarcity. Thus far, however, they have remained expensive compared to traditional markets, especially when the certainty of an indemnity contract offered by traditional well financed reinsurers is taken into account. It is possible that, when pricing starts to decline, many of these products will be withdrawn or reduced in size, which could well help moderate the rate of any softening.