SUMMARY

• Provides an innovative and detailed insight on a variety of issues to include an overview of the reinsurance industry, contingent financing, terrorism risk, captives, finite risk, loss portfolio transfers, catastrophe risk, modelling issues and risk swaps

• Multi-author contributions from leading industry experts and academics on the key issues surrounding this area

• Includes an up-to-date discussion of the effects of September 11th on the insurance and reinsurance markets.

• Chronicles the market changes from traditional methods of insurance through industry developments, research and current practice

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  TABLE OF CONTENTS

CONTENTS
Authors

Introduction
Morton Lane, Lane Financial, LLC

PART I : PRODUCT TYPES FOR TRANSFERRING, FINANCING, TRANSFORMING AND RETAINING RISK.

1 Reinsurance vs Other Risk-transfer Instruments - the Reinsurer's Perspective.
Kenneth J. Bock and Manfred W. Seitz, Munich Re

2 Managing Risk using Index-linked Catastrophic Loss securities
J.David Cummins, David LaLonde and Richard D. Phillips, Wharton, AIR and GSU

3 Catastrophe Bonds.
David Mocklow, John DeCaro and Matthew McKenna, Cochran-Coronia

4 Industry Loss Warrantees.
Enda McDonnell, Access Re

5 Risk Swaps.
Yuichi Takeda, The Tokio Marine and Fire Insurance Company Co. Ltd

6 Contingent Capital and the Art of Corporate Finance
Christopher L. Culp, University of Chicago

7 Contingent Covers.
Bryon Ehrhart, Aon

8 Finite Risk Insurance and Reinsurance.
Oscar Tymon, Centre Solutions

9 Captives
Paul Wöhrmann and Christoph Bürer, Zurich Financial Services

PART II : THE PRICE OF RISK AND ITS VOLATILITY.

10 Catastrophe Risk Pricing in the Traditional Market .
John A. Major and Rodney E. Kreps, Guy Carpenter

11 Pricing of Catastrophe Bonds.
Shaun Wang, SCOR

12 Implications of Market Shocks: Capacity, Price Volatility and the Value of Transparency.
Joan Lamm-Tennant, General Cologne Re

PART III: ASSESSING INDIVIDUAL RISKS BY MODELLING

13 Natural Catastrophe Loss Modelling
Mahmoud Khater and Dennis E. Kuzak, EQECAT

14 Quantifying Insurance Terrorism Risk.
Gordon Woo, RMS

15 Weather Risk Modelling for Improved Weather Risk Management
Mark Gibbas and S. Ming Lee, AIR

16 The ART of Dependence Modelling: The Latest Advances in Correlation Analysis
Peter Blum, Alexandra Dias and Paul Embrechts, Swiss Federal Institute of Technology

17 Economic Modelling: The Residual Valuation and Lease Income Streams of Aircraft Fleets.
Derrell Hendrix and Neil Hohmann, RisConsulting

PART IV: INDUSTRY-SPECIFIC PRACTICES AND SOLUTIONS

18 Industry-specific Practices and Solutions: Credit Solutions Provided by Insurance Companies
Uwe E. Remy and Daniel Grieger, Swiss Re

19 Securitisation of Life Insurance Businesses
Michael Millette, Shiv Kumar ,Omar J Chaudhary, Goldman Sachs and Company
Jacqueline M. Keating and Steven I. Schreiber, Milliman USA

20 The Origin of Contingent Liabilities.
Stephen Hough, BAE Systems

21 Private Equity Capital Guarantee Structures.
Gabriele Zeindler, Swiss Re

22 Applying Insurance Techniques and Structures to Manage Merger Risk.
David Govrin and Andrew Kaiser, Goldman Sachs

23 The Role of Hedge Funds as Asset Managers in Pension, Life and Annuity Portfolios, and Property-Casualty Reinsurance Covers.
David K. A. Mordecai, Clinton Group Inc

PART V: PORTFOLIO CONSIDERATIONS

24 The Cost of Risk and Cost of Capital in Capital-Budgeting and Risk Transfer Decisions.
Neil Doherty, University of Pennsylvania

25 Correlation in Risk Portfolio Management.
Bill Riker, Renaissance Re

26 Integrated Simulation Techniques.
Michael Steel, Benfield Group

27 Improving Portfolio Performance with Catastrophe Bonds.
John Kiernan&David Heike, Lehman Brothers

28 Amending Lloyds Risk-based Capital Model for Financial Guarantee and Credit Insurance
Peter Allen, Derek Bain, Tony Jones and Samit Shah, Ernst and Young

PART VI: OTHER PERSPECTIVES

29 Accounting Issues in Finite Reinsurance and Alternative Risk Transfer Products.
Mike Brosnan, Ernst and Young

30 Legal Risks Mitigating Document Risk - Some Hard Lessons Learned.
Clive O'Connell, Barlow, Lyde&Gilbert

31 Alternative Risk Strategies - Regulation.
Nigel Davies, Financial Services Authority

32 Alternative Risk Transfer and Financial Stability.
David Rule, Bank of England

Afterword - Whither securitisation?
Morton Lane, Lane Financial LLC

Bibliography
NB - This table of contents is provisional until final publication of the book. Small changes to chapter titles and order may occur.

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  QUOTES

″In terms of sheer scope and expertise of the contributors, Alternative Risk Strategies sets a standard... a welcome addition to the professional library of any financially sophisticated risk manager.″
Mark A. Hoffman, Business Insurance magazine

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  REVIEW

Reviewed by James Brewer, Lloyds List

In-depth look at alternative risk

Michael Steel is used to dealing in massive insurance coverages, writes James Brewer. He worked on a $500m nuclear placement in 1994 and the $2.3bn limit loss portfolio-transfer-sale for CGNU at Lloyd's at the end of 2000. What the two deals had in common was that they were both done by means of alternative risk transfer. Now head of Benfield Remetrics at the Benfield group, Mr Steel is one of 55, yes 55, contributors to a weighty new book, Alternative Risk Strategies.

This must be the most comprehensive book on the subject to date, which is reflected in the quality, quantity and depth of essays. One contains algebraic formulae reflecting a firm's financial claims and their seniority, another has equations on the ″probability distortion″ of catastrophe bonds. Elsewhere, there is discussion of taxation issues for captive insurers and of equity implications of terrorism for reinsurers and brokers.

Little wonder nearly 700 pages are required to run the gamut from weather risk modelling to quantifying terrorism risk - Gordon Woo of Risk Management Solutions produces an ″event tree″ showing detection and thwarting of planned attacks to estimate the probability of a big insured loss.

As editor, Morton Lane says in his introduction, despite the tremendous amount of creative and experimental energy expended on the subject in the past 10-15 years, much has only partially seen the public light of day. Important things are going on in the hinterland between finance and (re)insurance.

Given his allegiance, Mr Steel unsurprisingly advocates simulation methods to allow insurers and reinsurers to model the assumption of risk, especially where complex contracts are written. An insurance company has to protect itself especially against the financial impact of large events such as a Florida hurricane or a California earthquake. Modelling techniques are of great benefit to underwrite products of standard format, but an absolute necessity for bespoke solutions that cater for specific clients.

A closely studied section will be that written by Nigel Davies of the Financial Services Authority. He says the uncertainties associated with alternative risk transfer have driven much of the business into jurisdictions with permissive, unobtrusive regulation. ″Yet regulation per se is not one of the major costs,″ he says. ″A more important driver is the mitigation of tax liability″. He says regulators and lawmakers would appreciate an open, candid dialogue with market participants, through market associations if necessary, so that a balance of interests is fairly struck.

This article is copyright Informa UK Ltd, and is reproduced with permission.

Reviewed by Michael Sherris, University of New South Wales

This impressive book offers broad and detailed coverage of alternative risk transfer (ART). In fact, it covers more than ART, a term often used only for insurance risk-linked securities or to describe alternative financing techniques to reinsurance used by insurance companies.

The book brings together contributions from leading practitioners and academics in the area of ART and securitisation. The quality is high and the style of writing across the contributors is consistent. Many edited volumes often lack cohesion and suffer from significantly different author styles. This one does not.

There is no need for a reader to have a background in insurance or reinsurance to gain from this book, since the institutional background required is included in the early sections. Insurance professionals will find a lot here of interest, and finance practitioners with an interest in new and developing areas will gain insights about reinsurance markets and links to financial markets.

Developments in integrated risk management have meant most risk managers and financial managers require familiarity with the topics covered in this book. Quantitative finance academics and practitioners will find new challenges raised here, particularly in the pricing and capital structure issues for risk-linked securities. Credit risk and credit risk products have similarities to insurance risk-linked securities with common techniques and issues. But also, the differences are great, and finance professionals in the credit risk area will find the book of interest in this respect.

The first part of the book covers products used to transfer, finance, transform and retain risk. A comparison between reinsurance and alternative risk products introduces the book along with a discussion of developments since September 11, 2001. This is followed by a detailed analysis of the effectiveness of index-linked catastrophic loss securities and the catastrophe-linked bond market. Issues related to structure, particular case studies and the state of the market are covered. Other products, such as industry loss warranties and risk swaps are then analysed. Contingent capital, contingent covers, finite reinsurance and captives are also covered. The coverage of contingent capital includes issues in capital structure and cost of capital from the theory of corporate finance and application to ART products.

The second part covers pricing. How underwriters and pricing actuaries at major broker-market reinsurers price contracts is covered along with a detailed analysis of actual contract data. An actuarial technique with links to finance is then covered, along with an analysis of the impact of capital constraints on pricing arising from industry shocks using the attack on the World Trade Center as a case in point.

Part 3 takes a detailed look at modelling techniques for particular risks, including natural catastrophe models, terrorism risk models, weather risk models, dependence modelling using copulas and finally modelling aircraft fleet-related risk.

The next section covers industry-specific cases including insurance companies and credit risk solutions, securitisation of life insurance business, BAE's aircraft risk management, private equity and 'insuritisation', the role of insurance in mergers and acquisitions, and finally hedge funds.

Part 5 addresses portfolio considerations including cost of capital and risk-adjusted return on capital, correlation and tail risk, simulation of portfolios, portfolio diversification and catastrophe risk, and incorporating credit and financial guarantee insurance into Lloyd's riskbased capital model.

The final part covers accounting, legal, regulatory and financial system stability issues, with a final chapter by the editor that, along with a personal perspective, raises key questions in the areas of deal structuring and pricing.

Any reader interested in the intersection of insurance and finance will find this book worth reading. Even those with only some familiarity with the area will find parts of the book, particularly those in the areas of pricing and cost of capital, worth reviewing.

A new area such as this, which has developed so quickly and raised so many challenges for insurance and financial theory, will benefit enormously from having the institutional background and key issues covered in a single volume.

There is one topic in the pricing part of the book that I would have liked to have seen included, since I am sure the book will become a standard reference in future. Coverage of the editor's own analysis and model of pricing of insurance risk-linked securities that appeared in a recent edition of the Astin Bulletin, the journal of the International Actuarial Association, is an unfortunate omission from the book.

The book is not going to satisfy the academic quant wanting all the detail of advanced modelling techniques in insurance risk, but this is not its aim. However, the academic quant will find the seeds of new challenges in the book in the areas of pricing, dependence modelling, capital structure and impact on pricing. In the words of the editor in his final chapter, ″... arbitrage in insurance will not fall easy prey to existing slicing and dicing techniques. New ones will have to be found.... There is opportunity here for both practitioners and theoreticians″. I could not agree more.

Reviewed by Mark A. Hoffman, Business Insurance, Jan 20th 2003

Alternative risk is praiseworthy in a big way

Don't say you weren't warned - it's there on ″page xxx″ of the introduction.

″This is a big book. It covers a lot of ground. Perhaps it covers too much,″ writes Morton Lane, President of Lane Financial L.L.C and editor of ″Alternative Risk Strategies.″

It is indeed a big book, at nearly 700 pages, and it does cover a lot of ground. But anyone interested in going beyond a facile overview of how to make the most of alternative risk opportunities will probably disagree that it covers too much ground.

Experts on virtually every aspect of alternative risk transfer have contributed to this volume. Broad topics include ART products, the price of risk, modelling - including an essay on quantifying terrorism risk for insurers - in-industry-specific practices and solutions, portfolio considerations and other perspectives on alternative risk questions.

Even so, Mr Lane apologizes for not including chapters on such varied issues as the role of rating agencies and the weather derivatives market.

He shouldn't have felt it necessary to apologise. In terms of sheer scope and the expertise of the contributors, ″Alternative Risk Strategies″ sets a standard for reference volumes of its type.

It is not easy reading, and few people, other than alternative risk scholars, are likely to read this cover to cover because of its very scope, which touches on life insurance issues as well as property /casualty aspects of the subject.

That caveat notwithstanding, this is a book that would be a welcome addition to the professional library of any financially sophisticated risk manager.

Reviewed by Michel M. Dacorogna
Converium, Zurich, Switzerland

1 Alternative Risk Transfer: A Controversial Subject

Although pretty old in their concepts, alternative risk transfers and strategies took off in the early 1990's with the developments of computerized models for risks and the increasing fashionable integration of banks and insurances. Back then people realized that the financial markets could become a capacity provider for insurance risks and at the same time investors could use those risks to diversify their portfolio. Unlike traditional reinsurance contracts, which usually cover one type of risk and are renegotiated annually, ART solutions can involve different risks and are often multi-year. Some ART solutions are called finite deals because they depend on claims experience. They are thought of as smoothing the earnings of the company and usually have little risk transfer. Finite deals have balance sheet impact that needs to be carefully examined. The end of the internet bubble and bankruptcies such as Enron's, which particularly involved accounting scandals, have lead to such solutions becoming less popular, not least from the perspective of the tax authorities.

At the same time the vastly different time scales on which finnancial and insurance markets operate have hampered the concept of merging banks and insurances. Citigroup is thinking of selling Travelers and Credit Suisse Group attributes some of the heavy losses they report this year to their insurance arm Winterthur. If one adds to this the fact that many of the more complex ART deals have been the causes of heavy losses for reinsurers (Fortress Re, Overseas Partner and others), one understands the market's reluctance to enter such deals. Moreover, a major impediment has been the buyer's lack of confidence in the methods of pricing complex deals, despite much progress having been made. Yet, with some drawbacks, this area is bound to make progress since it plays a crucial role in efficient risk management and use of capital.

In this context the initiative of Risk Books to publish a comprehensive set of papers on alternative risk strategies edited by Morton Lane is most welcome in helping to review the sector. This book contains contributions from some of the most prominent players in the market reflecting on the development of those strategies. It marries descriptions of transactions with presentation of modelling advances in different areas. It shows clearly that recognition and use of alternative risk transfer products have been growing over the past decade. As is characteristic of the market the contributions to the book come from a blend of different origins: reinsurers, brokers, investment bankers, accountants, lawyers and academics. It covers a wide spectrum of subjects, and here the word ″strategies″ is used to cover both the risk transfer part and the risk management part associated with asset and liability managers. The book made up of six sections, ranging from a description of products in Part I to accounting, law and regulation in Part VI, going through pricing (Part II) to risk modelling (Part III), industry specific practices (Part IV) and portfolio considerations (Part V). The largest portion is dedicated to the transfer of catastrophic risk, which is not surprising since it is the sector where ART has displayed the most success.

2 The Art of Modelling

It is difficult for a reviewer to give justice to the book's 32 contributions compiled to cover such wide areas. One is always more attracted to the subjects that are germane to ones own interest. In my case, this is undoubtedly the pricing and modelling of risks which are to be found in Part II, III and V, where models are presented for natural catastrophes, dependence, terrorism or economic variables such as aircraft pricing. Reading these chapters, one realizes that the market for ART goes hand in hand with the development of our theoretical and quantitative understanding of those various risks. Natural catastrophes, the most developed area in terms of modelling, is also the one that sees the most ART transactions. CAT Bonds, whose payments depend on the occurrences of natural catastrophes are the most popular of these risk transfer instruments. Their market has grown to a stage where a Swiss bank (Bank Leu an affiliate of Credit Suisse) can offer its clients an investment fund based on a portfolio of cat bonds. The role of hedge funds in ART is covered in David Mordecai's contribution although he is more interested in the role such funds can play for asset and liability managers of insurances and pension funds.

One of the crucial questions in modelling risks is a realistic approach to the dependencies between risk factors. September 11 has again been an illustration that the correlation between various risks dramatically increases at a time when diversification is the most needed. Without realistic models to account for this effect, risk management will be condemned to remain unrealistic when it is most required. That is why I read with much interest the contribution from Paul Embrechts' school on alternative methods to assess dependencies. They open the path for quantifying the problem in a practical way. This work is well complemented by the paper from Bill Riker of Renaissance Re and I would like to quote his conclusion because it corresponds very much with what I think about the challenges ahead of us: ″A management of tail correlation in insurance organisations is probably the most important and most difficult issue faced by insurance organisations.″

In conclusion, those who are involved with alternative risk transfer products or with the development of risk transfer strategies would definitely find this book useful and read many, if not all, of its contributions. I would also recommend the book to people who are simply interested in new developments in financial markets and insurance. They will gain a good picture of the current market for alternative risk strategies.

Reviewed by Satyajit Das, The Finance and Treasury Professional

In recent years, the derivative/capital markets and insurance markets have aligned more closely. Central to this process is the concept of ART (alternative risk transfer). ART refers to the transfer of insurance risk into capital markets. Alternative Risk Strategies is a collection of papers on this new and rapidly evolving market. The focus is on products (including insurance/catastrophe linked bonds, contingent capital and finite risk insurance structures), pricing /modelling of insurance, insurance industry applications of ART, portfolio considerations of ART and peripheral issues (accounting, legal issues etc). Written by leading practitioners, Alternative Risk Strategies is an important source of information on this rapidly developing market. Replete with numerous examples and case studies, Alternative Risk Strategies provides a valuable insight into ART techniques and their applications.

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  AUTHOR BIOGRAPHY

Morton Lane is the president of Lane Financial, LLC, a broker-dealer engaged in consulting and transaction activity at the intersection of the reinsurance and capital markets. He is also a director of Select Re, Bermuda.
Previously, Morton has been senior managing director of the Capital Markets Division at Gerling Global Financial Products (GGFP), president of Discount Corp of New York Futures, senior managing director and head of commodities of Bear Stearns & Co, president of Lind-Waldock, investment officer for The World Bank, and lecturer at the London Graduate School of Business Studies.
Morton is a prominent speaker on insurance and securitisation and has written numerous articles on this subject. In 2001, he was awarded the Charles A. Hachemeister Prize for his article on ″Pricing Risk Transfer Transactions″ published in the Actuarial Studies in Non-life Insurance (ASTIN) Bulletin. He has co-authored two books, The Treasury Bond Basis and Eurodollar Futures. He has also designed and taught courses at the University of Chicago Graduate School of Business. Morton earned his B Soc Sc from Birmingham University, and his PhD in mathematics, business administration and computer science from the University of Texas.

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  CONTRIBUTORS

Kenneth J. Bock and Manfred W. Seitz, Munich Re; J.David Cummins, David LaLonde and Richard D. Phillips, Wharton, AIR and GSU; David Mocklow, John DeCaro and Matthew McKenna, Cochran-Coronia; Enda McDonnell, Access Re; Yuichi Takeda, The Tokio Marine and Fire Insurance Company Co. Ltd; Christopher L. Culp, University of Chicago; Bryon Ehrhart, Aon; Oscar Tymon, Centre Solutions; Paul Wöhrmann and Christoph Bürer, Zurich Financial Services; John A. Major and Rodney E. Kreps, Guy Carpenter; Shaun Wang, SCOR; Joan Lamm-Tennant, General Cologne Re; Mahmoud Khater and Dennis E. Kuzak, EQECAT; Gordon Woo, RMS; Mark Gibbas and S. Ming Lee, AIR; Peter Blum, Alexandra Dias and Paul Embrechts, Swiss Federal Institute of Technology; Derrell Hendrix and Neil Hohmann, RisConsulting; Uwe E. Remy and Daniel Grieger, Swiss Re; Michael Millette, Shiv Kumar ,Omar J Chaudhary, Goldman Sachs and Company; Jacqueline M. Keating and Steven I. Schreiber, Milliman USA; Stephen Hough, BAE Systems; Gabriele Zeindler, Swiss Re; David Govrin and Andrew Kaiser, Goldman Sachs; David K. A. Mordecai, Clinton Group Inc; Neil Doherty, University of Pennsylvania; Bill Riker, Renaissance Re; Michael Steel, Benfield Group; John Kiernan&David Heike, Lehman Brothers; Peter Allen, Derek Bain, Tony Jones and Samit Shah, Ernst and Young; Mike Brosnan, Ernst and Young; Clive O'Connell, Barlow, Lyde&Gilbert; Nigel Davies, Financial Services Authority; David Rule, Bank of England; Morton Lane, Lane Financial LLC
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