Transcript Risk Management Practises

Banking, Insurance and Reinsurance:
The Market for Risk Transfer
Karlsruhe, 11 December 2002, Dirk Lohmann
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
Important Disclaimer
December 11, 2002
Page 1
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.
Talking points
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
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
(*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“,
Cross-sectoral comparison, November 2001
Talking points
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 3

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
Risk management across sectors
Insurance Companies
Commercial Banks
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 4
Security 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
Quantitative models calculate
economic capital necessary to
absorb unexpected credit loss
at target confidence level
Value-at-risk and stress
testing methodologies for
market & liquidity risk
Risk limiting and sharing via
deductibles, reinsurance & ART
Asset and Liability
management
Credit risk minimized through
collateral and master netting
agreements
Technical provisions as estimate of
foreseeable claims while capital
covers unexpected losses
Loan loss reserves to cover
expected losses and capital to
cover unanticipated losses
Holding capital rather than
reserves because valuation
on a mark-to-market basis
Provisions much higher than
Capital
Capital usually higher than
Reserves
Capital much higher than
Reserves
Asset and Liability management
Provisions /
reserves vs.
Capital

Large differences in primary risks, typical time horizon and level of capital
vs. provisions/reserves
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
Supervision across sectors
Insurance Companies
Capital
regulation /
solvency
regime
frameworks
(1) Risk-Based-Capital (USA,
Canada, Japan and others)
December 11, 2002
Page 5
Commercial Banks
Basel Accord
(2) Index based solvency regime
(EU and others)
Security Firms
(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 approaches
Historical cost approach
B/S Focus
Liability side of balance sheet
Asset 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)

Marked-to-market
Supervision differs significantly by sector and regions
Talking points
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
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
(*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“,
Cross-sectoral comparison, November 2001

Packaging
Placement
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 7
Secondary
Markets
Borrower /
Issuer
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
Banking: Separation of origination and
management
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 8
Client Mgmt /
Origination
Portfolio
Management
Syndication
Loan Trading
Credit Derivatives
Secondary
Markets
Securisation

Banks have started to separate origination and management of their loan
portfolios

Portfolio management optimises the bank’s balance sheet by passing on
“undesired” risks to secondary markets
Insured
Insurance: Traditional reinsurance & ART

Insurance
Companies
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 9
Reinsurance
Reinsurance
Companies
ART
Secondary
Markets
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)
Talking points
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
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
(*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“,
Cross-sectoral comparison, November 2001
“One-Stop Global Financial Shopping” –
A paradigm of the 1990’s
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 11

The mid- to end 1990’s 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
Reassessing the costs and benefits of
integration in the financial services industry
Perceived Benefits in the
90’s
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 12
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 efficiencies
Economies of scale are not unlimited
Regulatory arbitrage
Regulators and rating agencies are
becoming faster at closing the gaps
“One Stop Global Financial Shopping” –
A management fad of the 1990’s?
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 13

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 insurancebased products
Talking points
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
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
(*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“,
Cross-sectoral comparison, November 2001
The logic behind cross-sectoral risk
transfers
Transferor
(Sector A)
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
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 15
Transferee
(Sector B)
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 traditional risk transfer avenues
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 16
Insurance
Risks
Capital
Market Risks
Insurance /
Investment /
Hedging
Reinsurance
(Re)Insurance
Markets
Capital
Markets
Are there feasible diagonal (ART) risk
transfer avenues?
Insurance
Risks
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 17
Capital
Market Risks
?
(Re)Insurance
Markets
Capital
Markets
One possible direction for ART Securitization
Insurance
Risks
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 18
Capital
Market Risks
“Securitization”
(i.e. CAT risk, upfront expenses)
 Insurance linked securities
(CatEPut, Surplus Notes)
 Securitization, CAT bonds, etc.
(Re)Insurance
Markets
Capital
Markets
Another Direction of ART - “Insuritization”
A path littered with failures
Insurance
Risks
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 19
Capital
Market Risks
“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
(Re)Insurance
Markets
Capital
Markets
Why did (re)insurers go into the wrong
direction?
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 20

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 ROE’s being earned in the
structured finance businesses:

ROE’s shown in banking industry had been misleading through
aggressive leveraging practices now exposed in the last 12
months (off-balance-sheet SPV’s)

Systemic risk underestimated by re-/insurers and overlooked
dependence to own asset side risk
What’s happening now?
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 21

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
© Converium
Banking, Insurance and Reinsurance:
The Market for Risk Transfer
December 11, 2002
Page 22