PROGRAME

: RISK MANAGEMENT AND INSURANCE (PARA)

NAME

: TAURAI MATINGWINA

STUDENT NUMBER

: P0109064F

COURSE

: INSURANCE AND THE ECONOMIC ENVIRONMENT

COURSE CODE

: CIN4102

LECTURER

: DR TSUMA

DUE DATE

: 11 .NOVEMBER 2013

QUESTION: The concept of applying Capital Market techniques to Insurance and Reinsurance
has resulted in the increase of ART. Discuss how in your view this development has impacted the
insurance industry.[25]

Introduction
The concept of applying Capital Market Techniques to insurance and reinsurance is known as the
convergence of the insurance industry and the capital markets. This includes the use of insurance
linked securities (ILS). These provide a mechanism within the financial system to transfer
insurance risk to capital markets and supply protection to investment portfolio. Other methods
include the use of derivatives and swap structures. Catastrophe swaps are agreements where an
insurer agrees to pay a series of fixed premium payment to counterparty in exchange for floating
or variable payments triggered by the accuracy of the insured event.
Because of securitization, derivatives and swap structures, insurers are better positioned to
spread their risks across the broad spectrum of the financial markets as opposed to relying on
reinsurance or overly redundant capital reserves. Insurance linked securities allows for efficient
use of capital and add liquidity to the financial system, thereby reducing the cost of reinsurance.
The convergence of the insurance industry and the capital markets has lead to the creation of
new tools for insurers to manage risk that was previously thought to be uninsurable. As the need
for risk capacity has increased over the past 30 years so has the need for financial instruments to
manage and hedge risk.
Alternative Risk Transfer
Alternate Risk Transfer is a broad range of new concepts to finance traditional insurance risks as
well as non-traditional risks. It is the ceding and assuming of insurance and non-insurance
exposure through non-conventional means. The aim of ART is to effect optimized risk transfer at
optimal price, through a combination of insurance and other capital market instruments. ART is
to e expected as a complementary rather than supplementary solution to traditional transfer. The
participants in ART market are Risk takers and investors such as reinsurers, life assurers, bank
traders, capital market investors Protection seekers like insurers, reinsurers and bank traders
Intermediaries like insurance brokers and investment bankers.
The impact of ART on the Insurance industry
Capital markets and the insurance industry have long held a mutually beneficial relationship. The
insurance industry including both primary and secondary insurance market provide risk
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protection to individuals and companies while the capital market provides the insurance industry
with a wealth of options to earn investment profits and manage reserve funds.
Increased Capacity
Capital Markets provides additional financial capacity for Insurance coverage through self
insurance. What used to be considered alternative has become mainstream for many insurers.
However it is not a replacement to insurance but it is a supplement reinsurance need. The first
and perhaps most important driver of convergence is the growth in property values in
geographical areas prone to catastrophic risk. Trillions of dollars of property exposure exist in
disaster prone areas in the United States, Europe, and Asia, resulting in sharp increases in insured
losses from property catastrophes.
Low Reinsurance Cost
Prior to securitization reinsurance costs were high due to catastrophe. This was because of the
frequency and severity of the catastrophe risks. Now that securitization was as a result of
catastrophe risks, reinsurance costs have dropped since the capacity is now capable of handling
greater risks.
Moderate Underwriting Cycles
Capital market tools had an impact of moderating the effect of the reinsurance underwriting
cycles. This created value for insurers and insurance buyers by reducing the alternating period of
soft market when prices are relatively low and hard market when prices are high and coverage
supply is restricted. The existence of hard markets increased the difficulties faced by the insurers
in predicting costs and managing risks. Because underwriting cycles tends to have low
correlation with securities market returns, convergence has the potential to moderate the effect of
reinsurance cycles and thereby creating value for insurers and insurance buyers.
Advances in Computing and Communication technology
The convergence of the insurance industry and the capital markets has resulted in the
advancement of communication and computing technologies. These technologies have facilitated
the collection and analysis of underwriting exposure and loss data as well as the development of
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catastrophe modeling firms. These firms have developed sophisticated models of insurance
exposures and loss events, facilitating risk management and enhancing market transparency.
Constraints
Most ART deals, till now have been bespoke deals involving high transactional costs, but at the
same time providing, wider cover than was ever possible under the conventional insurance
programmes. Regulatory and statutory accounting treatment constraints have the potential of
stifling the growth of ART in several markets.
Conclusion
The convergence of the insurance industry and the financial markets has resulted in a variety of
advantages for ,both the insurer and the insured. Although reinsurance was one of the first truly
global financial markets, the inherent conservatism and inertia in the insurance and reinsurance
industries as well as technological and informational problems long impeded the convergence of
(re)insurance and financial markets. However, a number of forces have emerged during the past
two decades that have accelerated convergence. Perhaps the most important driver of
convergence is the growth in property values in geographical areas prone to catastrophic risk.