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New deal: insurers are finding innovative ways to spread risk to capital markets and investors.


Insurers are continuing to find innovative ways to use capital markets and financial institutions other than insurance companies to spread their risk.

Aspen Insurance Group Holdings recently completed what could be a first-of-its-kind transaction with Deutsche Bank Deutsche Bank AG (IPA: /'dɔɪ.tʃə/[1]) (ISIN: DE0005140008, NYSE: DB) (English: German Bank  to protect itself from defaulting reinsurers. Hannover Re Hannover Re (FWB: HNRGn), in German Hannover Rückversicherung AG, with gross premium of around €9 billion in 2006, is one of the five largest reinsurance groups in the world. Its headquarters are in Hanover, Germany.  finalized See finalization.  an innovative derivatives deal in lieu of buying traditional retrocessional coverage. And Benfield Group Benfield Group Limited is a reinsurance and risk intermediary based in London, England. It has been listed on the London Stock Exchange since June 2003 and is a constituent of the FTSE 250 Index.  has teamed up with a bank to market a product that aims to cover reinsurance The contract made between an insurance company and a third party to protect the insurance company from losses. The contract provides for the third party to pay for the loss sustained by the insurance company when the company makes a payment on the original contract.  recoverables.

"There's been a good amount of chatter on the market about recoverable covers," said Rob Bredahl, president of Benfield Inc.

Aspen Insurance Group: Problem Solved

Julian Cusack, chairman and chief executive officer of Aspen Insurance Ltd., the Bermuda-based operating company operating company

A business that engages in transactions with outsiders.
 of Aspen Insurance Group, said the goal of its transaction was to reduce the company's exposure to the risk of one or more of its reinsurers defaulting.

At the end of 2005, after two heavy years of hurricane losses, Aspen was carrying more than $1 billion in reinsurance recoverables on its balance sheet. In its annual U.S. Securities and Exchange Form 10-K Form 10-K

A report required by the SEC from exchange-listed companies that provides for annual disclosure of certain financial information.


Form 10-K

See 10-K.
 for 2005,Aspen reported its reinsurance recoverables had increased to $1.19 billion from $198 million, although they were reduced to $468 million by year-end 2006.

"Looking back through the history of the property/casualty sector, there have been significant failures among insurers and reinsurers," Cusack said. "These are not common events, but they can happen."

Australia's HIH HIH
abbr.
Her (or His) Imperial Highness
, and U.S. companies including Reliance and Fortress are among those who've failed.

"We aren't particularly worried about any reinsurance company that we are dealing with at the moment. We're not trying to solve an immediate problem," Cusack said. "But we thought it was prudent as part of our overall risk management approach to have credit protection in the event something like this [a reinsurer's insolvency] happens over the next four or five years."

In what could be the first deal of its kind, Aspen has negotiated a long-term-credit wrap for its existing and future reinsurance recoverables.

It works like this:

Deutsche Bank has put up $420 million in a trust fund. If Aspen's reinsurers become insolvent INSOLVENT. This word has several meanings. It signifies a person whose estate is not sufficient to pay his debts. Civ. Code of Louisiana, art. 1980.. A person is also said to be insolvent, who is under a present inability to answer, in the ordinary course of business, the responsibility  and cannot pay Aspen's claims, Deutsche Bank will cover the amount Aspen would have received from the reinsurers.

"The contract is structured as an insurance contract with an affiliate of Deutsche Bank," Cusack said. "It's like a financial guarantee contract. It's similar to a credit default swap Credit Default Swap

A swap designed to transfer the credit exposure of fixed income products between parties.

Notes:
The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product.
. However, in a conventional credit default swap, you'd have an event that would guarantee payment irrespective of irrespective of
prep.
Without consideration of; regardless of.

irrespective of
preposition despite 
 whether you suffered a loss. This has an indemnity: It only pays if there is a loss, which is what makes it an insurance policy."

The agreement does not cover disputes over reinsurance recoverables, and is only triggered if a reinsurer re·in·sure  
tr.v. re·in·sured, re·in·sur·ing, re·in·sures
To insure again, especially by transferring all or part of the risk in a contract to a new contract with another insurance company.
 can't pay clue to financial stress.

The arrangement took two and one-half years to accomplish, and the contract itself is 126 pages long.

It's a step away from an actual securitization Securitization

The process of creating a financial instrument by combining other financial assets and then marketing them to investors.

Notes:
Mortgage backed securities are a perfect example of securitization.

May also be spelled as "securitisation.
, because Deutsche Bank did not pass the risk along to investors, Cusack said, although he added that could happen in the future. "If the bank could do a number of these policies for different companies, they could package it and securitize Securitize

The practice of a company selling accounts receivables or other debts owed to it. The third party that buys the debt assumes ownership of it and the responsibility for collecting the debts, and keeps the repayments when made.
 it to the capital markets," he said.

Hannover Re: The Next Step

In the first transaction of its type, Hannover Re has transferred a portion of its risk to investors in lieu of buying traditional retrocessional coverage.

A Bermuda-based special purpose vehicle called Kepler Re has been set up to protect Hannover Re's natural catastrophe business. The cover attaches for an aggregated 83-year event; it is exhausted if a 250-year accumulation is reached, whether the losses stem from one giant event or a number of smaller losses. Kepler Re is a segregated account within Kaith Re, a reinsurer licensed under Bermuda's Segregated Accounts Companies Act 2000.

Kepler Re is funded by $200 million of capital contributions from investors.

"We have thus protected our portfolio better than ever against expensive catastrophe losses and basic claims," Chief Executive Officer Wilhelm Zeller said in a statement. "As a result, we enjoy unprecedented independence from the traditional retrocession RETROCESSION, civil law. When the assignee of heritable rights conveys his rights back to the cedent, it is called a retrocession. Erskine, Prin. B. 3, t. 5, n. 1; Dict. do Jur. h.t.  market."

The Kepler Re investors receive a quarterly return on their invested capital. There is no credit risk for Hannover Re because the capital contributions are collateralized. The transaction came into effect March 1, 2007, and runs until December 2008.

The portfolio assembled for the securitization consists of nonproportional treaties for property catastrophe, aviation and marine (including offshore) reinsurance. Altogether, about 42% of this business was passed on to the investors, Hannover Re said in a newsletter to investors.

Hannover Re was carrying about 3 billion euro (or $4.08 billion) in recoverables at year-end 2006, according to according to
prep.
1. As stated or indicated by; on the authority of: according to historians.

2. In keeping with: according to instructions.

3.
 its annual report.

Reinsurance Defined

Reinsurance: Insurance that an insurer buys to spread some of its risk of losses on the policies it has underwritten. Reinsurance enables an insurer to underwrite more insurance, stabilize its underwriting results and secure catastrophe protection against shock losses.

Retrocessional Insurance: Insurance that a reinsurer buys from another reinsurer to spread some of its risk.

Reinsurance Recoverables: Funds that a reinsurer owes the insurer for its portion of the insurer's losses.

A Common Product

To make it easier for capital markets to carry reinsurance recoverables, Benfield is rolling out a standard product with a bank that would cover a company's reinsurance recoverables.

As part of the arrangement, Benfield has worked out a process to determine whether a reinsurer has failed to pay due to a true credit issue or an unwillingness to pay.

"That has always been the sticking point sticking point
n.
A point, issue, or situation that causes or is likely to cause an impasse.

Noun 1. sticking point - a point at which an impasse arises in progress toward an agreement or a goal
 in securitizing recoverables," Rob Bredahl, president of Benfield Inc., said. "How do you determine whether the reinsurer isn't paying because they don't want to--they dispute the contract--versus really having a credit problem? No one wants to provide protection on willingness to pay Willingness to pay (WTP) generally refers to the value of a good to a person as what they are willing to pay, sacrifice or exchange for it. See also
  • Becker-DeGroot-Marschak method
, because no one wants to argue a contract."

So, a lot of the work needed to pave the way for reinsurance recoverables to be securitized securitized

Of, related to, or being debt securities that are secured with assets. For example, mortgage purchase bonds are secured by mortgages that have been purchased with the bond issue's proceeds.
 had to deal with how to determine if it's a credit issue versus a willingness-to-pay issue.

Bredahl said Benfield has parameters to determine if a recoverable goes bad due to the reinsurer failing to post collateral, or if the reinsurer loses a certain percentage of equity, or if the reinsurer's financial strength rating is downgraded.

Another complication in the recoverable discussion is that reinsurers can cede a risk to another company, but ultimately end up carrying the risk again when it, in turn, offers retrocessional coverage to the same company it ceded the risk to. This sort of spiral was one factor in the Unicover debacle in the late 1990s. Then, several insurers lost more than $1 billion from participating in a reinsurance pool of workers' compensation workers' compensation, payment by employers for some part of the cost of injuries, or in some cases of occupational diseases, received by employees in the course of their work.  occupational accident or "carve-out" policies that were ultimately found to have been underpriced un·der·price  
tr.v. un·der·priced, un·der·pric·ing, un·der·pric·es
1. To price lower than the real, normal, or appropriate value.

2.
 in a soft market. Three Unicover-managed pools generated reinsurance contracts, and reinsurers who received the risks often ceded them again to other companies.

At each level of reinsurance, reinsurers were accepting the risks for a smaller share of the premium--intending to pass along the risk to another reinsurer in return for a fee before they realized the business was underpriced and unprofitable, and they then attempted to unwind Unwind

1. The closure of an investment position.

2. The reconciliation of an error previously unseen by a brokerage house.

Notes:
1. Sometimes referred to as closing out a position.
 the transactions.

"Some of the most important factors in the reinsurance-recoverable hedging transactions are the definition of a reinsurance credit event, the assumptions regarding reinsurance default correlations, and the assumptions about recoveries on recoverables," said Emmanuel Modu, managing director and head of structured finance for A.M. Best Co.

"Credit event probabilities used to model the hedging transactions, in particular, should be derived from insurance defaults and/or impairments. Another important factor to consider in these transactions is that reinsurers in severe distress often go into run-off and often commute TO COMMUTE. To substitute one punishment in the place of another. For example, if a man be sentenced to be hung, the executive may, in some states, commute his punishment to that of imprisonment.  aggressively--this means that the reinsurance obligations may not be fully collectible," Modu said.

"Ultimately, there may be basis risk in the transaction from a financial strength rating perspective. The basis risk here is the likelihood that the transaction will not yield a payout to the cedent even though the reinsurance recoverable is uncollectible for whatever reason--whether it is because of unwillingness or inability to pay," Modu said.

Learn More

Aspen Insurance Ltd. A.M. Best Company # 83210 Distribution: Brokers and direct

Hannover Ruecksversicherungs AG A.M. Best Company # 85070 Distribution: Direct and reinsurance brokers

For ratings and other financial strength information about these companies, visit www.ambest.com.

Key points

* Benfield is debuting a standard product with a bank that would cover a company's reinsurance recoverables.

* Aspen Insurance Group has found an innovative way to protect itself in the event one or more of its reinsurers becomes unable to pay claims.

* Hannover Re has created a way to use capital markets to gain retrocessional protection.
COPYRIGHT 2007 A.M. Best Company, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2007, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Article Details
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Title Annotation:Reinsurance/Capital Markets: Reinsurance Recoverables
Author:Green, Meg
Publication:Best's Review
Date:Jun 1, 2007
Words:1458
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