Magazine article Risk Management

Coming Together: Converging Roles within the Insurance and Finance Marketplace

Magazine article Risk Management

Coming Together: Converging Roles within the Insurance and Finance Marketplace

Article excerpt

The property/casualty insurance industry and the financial markets have been branches of an over-reaching economic network for centuries. It has only been in the recent past, however, that they have migrated toward each other in a significant way.

Risk managers and insurance companies are looking for more efficient ways to manage a wider range of exposures and to protect corporate assets and earnings. In addition, financial institutions such as retail and investment banks are growing eager to tap into the potential revenue traditionally associated with selling insurance- and reinsurance-based risk management solutions.

The convergence of insurance and finance, as it has been called, has resulted in an increased interest in products that combine elements of both disciplines. This wave of innovation is supported by a new, more holistic view of risk management and risk transfer, largely as a result of the globalization of financial markets and a new world view of international risk transfer and financial capacity. Risk managers and reinsurance buyers view their exposures on a worldwide basis today and have expanded their perspectives to consider how financial exposures can influence their balance sheets. All of these factors combine to create a new marketplace for innovative risk management solutions that are changing the way companies protect their assets and earnings. Financial institutions of all kinds, including reinsurers and insurers, are trying to capture a leading role.

Initial Efforts

One of the most striking examples of this new trend is a hybrid product first used in a transaction completed during the fall of 1996 for RLI Corp. A provider of specialty property and casualty insurance, RLI suffered significant losses from the Northridge earthquake and, with the assistance of Aon, was consequently seeking enhanced protection beyond its traditional catastrophe layer. In an innovative agreement that implemented the use of a CatEPut[SM] instrument developed by Aon, RLI augmented its reinsurance program by purchasing a contingent capital facility.

The facility, underwritten by Centre Re, works very much like a capital market trigger product. In the unlikely event of a triggering event (in this case a loss large enough to significantly exceed its traditional coverage), RLI has the option of selling $50 million of its convertible preferred shares at predetermined terms to Centre Re. This arrangement provides RLI immediate access to equity in the event that a loss impairs its surplus. In this way, RLI has an increased likelihood of maintaining its ratings and will be able to continue its business operations virtually uninterrupted in the wake of such a loss. Centre Re has the option to eventually convert the preferred shares to common stock. RLI can refinance and redeem the shares at any time.

This type of transaction combines elements of traditional reinsurance coverage and capital markets techniques in one customized solution. The CatEPut[SM] structure was used again this year when Horace Mann Educators Corp., which underwrites personal lines property/casualty and life coverage as well as retirement annuities, entered into a similar $100 million transaction (twice the size of the RLI deal). Using the same Aon CatEPut[SM] product, the multiyear deal provides Horace Mann access to equity after a severe loss. While RLI's predominant exposure is California earthquakes, Horace Mann's exposure to severe loss, while at least as remote, is less geographically defined. …

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