Risk transfer to the capital market - A useful complement

2004 was the costliest natural catastrophe year so far in insurance history. Natural hazards, which are difficult to calculate, are a major financial risk for the insurance industry. To reinforce the financial strength of catastrophe reinsurers, capital market instruments are now also in use.

Unwanted record figures

Even before the great tsunami catastrophe in Southeast Asia, 2004 had been a year that broke all previous records. In 2004, the insured losses booked by the insurance industry stood at US$ 40bn, whereas in 2003 they had totalled "only" US$ 15bn. Hurricanes and typhoons such as Ivan and Charley accounted for US$ 35bn.

The economic losses caused by natural catastrophes amounted to US$ 130bn in 2004 — excluding the earthquake off Sumatra. The United Nations estimate the restoration costs in Southeast Asia at US$ 10—12bn (status: February 2005).

Initiative in all directions

The insurance industry uses a variety of methods to identify, assess and minimise risks from natural catastrophes. For more than 30 years, our Geo Risks Research team has been analysing natural hazards and the effects of climate change to classify risk areas and make forecasts.

Early-warning systems for earthquakes and floods are being installed worldwide in order to enable man to respond to imminent catastrophes in good time. The German Insurance Association has designed the zoning system for flood, backwater, and heavy rain (ZÜRS), an important contribution to the insurability of the flood risk in Germany.

Munich Re experts have developed an index for the world's 50 largest metropolises which quantifies their risk potentials for all natural hazards, including the vulnerabilities and concentrations of values. All of these measures help get a better grip on natural hazards although they will never eliminate them entirely in future.

Claims payments such as those in 2004 confront reinsurers with the problem of finding a way to protect their performance, even after such catastrophes have occurred.

Double-bottom capital market

In recent years, the capital markets have been tapped as an additional source of capacity and financing. Such transactions are referred to as risk transfer to the capital market. There is a wide range of financial market instruments available, e.g. high-yield bonds, futures, swaps and options.

From the very beginning, Munich Re has accompanied and supported the development of risk transfer to the capital market and has acted as a facilitator, investor and sponsor ever since:

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  In 1997, Munich Re places the first insurance securitisation fund worldwide.
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  In 1998, Munich participates as a facilitator and reinsurer in an insurance securitisation transaction on behalf of a client.
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  In 1999, our subsidiary American Re sponsors the catastrophe bond "Gold Eagle" with a sum of US$ 182m, thus transferring natural catastrophe risks to the capital market.
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  In 2000, Munich Re conducts the first insurance risk swaps on a derivative basis.
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  At the end of 2000, Munich Re sponsors catastrophe bonds for the first time. With a volume of US$ 300m, it protects various natural hazards risks such as Hurricane USA, Earthquake California and Windstorm Europe by placing them on the capital market. The transaction with a term of three years becomes known as "PRIME Capital".
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  In 2002, the Munich Re Group integrates the existing alternative risk transfer units of Munich Re Munich and American Reinsurance Corporation, Princeton, into the newly established Munich American Capital Markets (MACM). In this way it consolidates its position on the alternative markets in view of the rising demand for structured reinsurance and capital market solutions.
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  In 2002, Munich Re also protects the FIFA World Cup in Japan/Korea against earthquake risks by means of an insurance derivative.

Munich Re — Bridge to the capital market

Risk transfer to the capital market, albeit a niche product, is an alternative risk and balance-sheet management instrument that complements traditional reinsurance.

As a global financial service provider, Munich Re with its special unit Munich American Capital Markets is a bridge to the capital market for its clients. By providing services ranging from project management and concept structuring to the assumption of risk segments, we are well positioned to implement efficient capital market solutions.