Banking companies, which have shied away from underwriting as they edge into marketing insurance products, are forging an entrée to the risk-financing side of the business through their capital markets operations.
Several bank units, including Citigroup's Salomon Brothers, Chase Securities, and Credit Suisse First Boston, have become active in the securitization of insurance risk, and more involvement is expected as the number of deals grows.
"It's a competitive marketplace," said Christopher McGhee, managing director of Marsh & McLennan Securities in New York. His firm - which is part of Marsh & McLennan, the world's largest insurance broker - has participated in such transactions. "I think there's room for a lot of players in it," he said.
These deals transfer insurance risk to investors. Most are related to reinsurance for catastrophes - providing back-end capital for rebuilding after major natural disasters like hurricanes, earthquakes, tornadoes, and floods.
For example, an insurer with a large exposure to Florida hurricane risk may, instead of passing on this risk to a reinsurer, repackage it as bonds or other investment vehicles that it sells to private investors. The main advantage gained is tapping the pool of investor capital, which dwarfs the insurance market.
The undisputed leader in the fledgling market is Goldman Sachs Group Inc., which has been involved in several major transactions, including the securitization last year of the risk of a major earthquake's striking Disneyland Tokyo, and, most recently, a deal that covers the risks of catastrophes affecting Scor, a French reinsurer.
The market is soft right now because insurance and reinsurance are cheap and readily available, but big insurers want to line up sources of capital for the inevitable hard side of the cycle, Mr. McGhee said.
Another attractive aspect of securitizing risk is "the enhanced credit quality of an insurance-linked security," he said. When investors buy these securities, the money is put in a trust, which is guaranteed to be there if the triggering event occurs. When insurers buy reinsurance they always run the risk that the reinsurer will become insolvent before payout time.
Goldman Sachs sees these deals as an opportunity to help clients gain access to pools of capital to manage risks that are not handled as effectively by the reinsurance market, said Mike Millette, vice president in the risk markets group. "Securitization has complemented, rather than competed with, the reinsurance markets," he said.
These deals fit well with the company's other business operations, Mr. Millette said, because they address strategic issues for clients. He said Goldman has expanded its use of these transactions to help both insurance and noninsurance clients fund risks and that the market continues to grow.
However, because each is complex and unique, these deals can get pricey.
"The insurance securitization marketplace is still relatively new," Mr. McGhee said, and costs "are still relatively high. They will come down as we get more standardized in language."
Also, "there's an issue of getting investors more comfortable with the asset class," he said.
Banking companies have some advantage in these deals because of their access to the investment community. Right now, though, the major investors in these securities are those who already have a high comfort level with insurance, said Sean Mooney, chief economist at Guy Carpenter & Co. in New York.
"There's a world of people out there who've always been interested in insurance investing, starting with Warren Buffet and going down," Mr. Mooney said, and these investors tend to be the ones involved in these transactions, whether the deal goes through a bank or a more traditional insurance operation.
One challenge, for banks and insurance entities alike, will be attracting a wider range of investors, experts said. The main appeal of these securities is that they offer an opportunity to for portfolio diversification.
"There are very few uncorrelated asset classes out there - risks that are not tied to the broader stock or bond market," Mr. McGhee said. "And this is one of them."
Put simply, an earthquake's occurrence in California is completely unrelated to the price of stocks - which means these securities can diversify a portfolio.
Experts agreed that the number and size of these transactions will grow as the insurance market hardens, for example, after a catastrophe, when insurance policies become more expensive and less readily available. In fact, the market is growing already, Mr. McGhee said, noting current estimates that $6 billion of risk-linked securities have been placed since 1996, with $2 billion worth in each of the past two years.
"That's a pretty good volume of issuance," he said, "and we expect it to continue to grow as the market hardens."