Published Date: 23 May 2000

"Rethinking Risk : Beyond Traditional Boundaries"

2nd Conference on Alternative Risk Transfers in Asia
Keynote Addrsss By Mrs Hauw Soo Hoon, Executive Director, Insurance Department, MAS

Date: 23 May 2000 

Distinguished Guests,
Ladies and Gentlemen,

Good morning. I am happy to be able to join you this morning at the 2nd Conference on Alternative Risk Transfers in Asia.

Changing Risk Landscape

2   The risk landscape that we operate in is rapidly changing. The globalisation and deregulation of many markets, coupled with technological advances, has led to the emergence of new risks. Just recently, the "I Love You" computer virus caused billions in damage world-wide, placing it in the league of major calamities. The damage could have been even more devastating had the virus hit the stock exchanges and financial service providers. Conceivably, insurers may one day soon end up footing the bill for the damage wreaked by such viruses.

3   The insurance industry cannot afford to ignore these new risks and must be ready to deal with, say business interruption risks from computer viruses or hackers, amongst a plethora of emerging risks. It will not be an easy task as there is little experience and empirical data for evaluating risks arising from today's rapidly changing technologies. Nevertheless, we can and must use all means available to manage and contain risk. After all, the core business of an insurer is to assume those risks that others do not want to bear themselves and an insurer is supposed to have the competitive advantage in the assessment and management of risks. Hence, the insurance industry has to rise to challenges to provide more innovative products to protect corporations and insurers from not just insurance risks, but financial and business risks as well.

4   There must be a paradigm shift away from the old thinking of traditional insurance coverage as providing the solution to protecting asset values. The new approach could involve hybrid solutions that could mesh for example insurance and capital market techniques to better service clients' needs. Seen against this backdrop, the prospect for alternative risk transfer products is very promising indeed.

5   The spectrum of ART solutions has expanded significantly over the last few decades. The fact that there is no generally accepted definition of ART is symptomatic of the diversity of products and the rate at which new and innovative risk-transfer mechanisms continue to be developed.

6   Having said that, let me try to expand on the development in certain ART activities such as captive business, finite risk reinsurance and risk securitisation. I will also elaborate on some of the measures that MAS has adopted or is studying in order to facilitate the carrying on of such cutting edge activities here in Singapore.


7   The initial ART solutions started with companies carrying their own risks through formalised self-insurance vehicles. At the start of the captive boom, tax consideration played an important role. Compared with pure self-financing of risks, captives offer the advantage that premium payments and underwriting reserves are tax deductible. Nowadays tax considerations are of much less importance: in the United States premium payments are only tax deductible if the captive writes a substantial amount of third party business and in some other countries, the profit made by the captive is taxable in the home country of the parent company.

8   Obviously there are many benefits other than tax considerations for setting up a captive. In addition to the traditional benefits of investment income on the premiums paid to the captive and direct access to the reinsurance market, captives are being used more widely nowadays as a holistic risk management instrument. Increasingly corporations are using their captives to develop their own finite risk solutions and adopt multi-year/multi-line insurance programmes incorporating a wider spectrum of risks.

9   Companies have begun using captives to cover employee benefit programmes, including life, health, pension and retirement plans, and some captives are now taking on credit and political risks, which can be expensive to insure on the open market, but can be reinsured out more cheaply. Others have taken on even previously uninsured financial risks, such as foreign exchange and interest rate fluctuations.

10   Hence, contrary to the earlier expectation that the erosion of tax benefits, availability of cheap insurance and emergence of innovative risk transfer solutions would portend the end of the captive industry, the multi-facet advantages of having a captive has kept the momentum going. According to Best's Captive Directory 2000 Edition, there are 4,355 captives globally with their net premiums written expanding by 15% to US$28 billion in 1999. Capital and surplus for the captive market amounted to US$70 billion, a substantial increase compared to the estimated US$54 billion at end 1998. AM Best1 also projects that new captive insurers are expected to be formed at a rate of more than 5% a year through 2005.

11   The sustained growth in the captive insurance industry is partly attributable to the popularity in rent-a-captive and protected cell company (PCC). Owing to the cost of establishing and managing a captive and the need for a reasonable amount of premiums to be put through the captive in order to make it viable, captives tend to be an economical option for larger companies. Both rent-a-captives and PCCs lower the access point to the captive solution, allowing smaller companies to access the benefits of a captive without the need to put up large amounts of money capitalising a captive insurer. Under a rent-a-captive or PCC facility, measures are taken to avoid cross-liability of one client to other clients, i.e. assets of one client are protected from the misfortunes of other co-users.

12   Recognising the benefits derived from such facilities, MAS is keen to see rent-a-captives and PCCs operating in Singapore to enhance our position as the leading Asian captive domicile. We would be formulating the regulatory framework for such facilities and looking into issues involved in enacting a PCC legislation.

13   Having said so much on captives, I may have created the impression that I am advocating that setting up a captive is the only way to achieve a holistic risk management programme. This is not the case as many of the advantages described for captives can also be achieved via other alternative solutions, such as finite risk products which bring me to the next topic - finite risk reinsurance.

Finite Risk Reinsurance

14   Owing to the diversity of the products available, there is no generally accepted definition for finite risk reinsurance. It is, however, an undisputed fact that finite risk reinsurance involves a combination of risk transfer and risk financing which emphasises the time value of money. Finite risk concept is based on spreading the risks for an individual policyholder over time versus the concept of spreading losses of a few policyholders amongst a large group of policyholders of similar risks in traditional insurance.

15   Finite risk solutions represent a break from the annual renewal emphasis of traditional insurance/reinsurance business and the "fair weather" approach of both the clients and the insurers/reinsurers. Such products would achieve a smoothing effect over time with regard to both premiums and claims. As the risk financing solution is unique to each corporation involved, premiums would be geared directly to actual claims experience and would be less dependent on general industry and market performance.

16   Finite risk solutions are therefore increasingly gaining significance as a component in corporations and insurance companies' approach to integrated risk management. In a 1999 Sigma Report2, global volume of finite solutions in corporate business was estimated at US$6 billion, with more than two thirds of all premium income being generated in the United States. Although finite risk solutions are most prevalent in the United States, the interest in such contracts is spreading throughout the industrialised world and taking an increased foothold in Europe.

17   Noting the proliferation of finite risk products, MAS decided to set up a working committee including representatives from the insurance industry and the auditing professions to deliberate on what stance should MAS adopt towards the usage of such non-traditional products. We came to the conclusion that financial reinsurance contracts are innovative products that can provide flexibility and liquidity to a corporation or an insurance company.

18   Thus, to facilitate the development of finite risk reinsurance in Singapore, MAS had in August 1999 issued notices on financial reinsurance to general insurers and life insurers. The Notices set out MAS' stance on the definition and use of financial reinsurance. They also provide guidelines on the application of risk transfer rules and accounting treatment, as well as disclosure requirements pertaining to financial reinsurance.

19   These notices strive to ensure clarity and consistency in accounting treatment and to provide users of financial statements with adequate information to assess the financial positions of insurers.

20   Besides finite risk reinsurance, MAS is also studying with keen interest, developments in the area of risk securitisation, which represents a relatively recent development in the ART spectrum.

Risk Securitisation

21   The capacity for natural catastrophe covers available in the insurance market only constitutes a fraction of the actual exposure. Hence, in an attempt to obtain additional capacity, corporations and insurers are increasingly turning to the world's capital market to complement traditional insurance.

22   Although risk securitisation was initially driven by the need to hedge catastrophe exposure, recently, credit exposure, life and surplus capital growth have all been successfully securitised. As with insurance, the motivation behind these securitisations is true risk transfer. The catastrophe bond investor assumes catastrophic insurance risk; the residual value investor assumes the risk that the residual value of an asset may not be as predicted. Investors in the capital market can benefit from engaging in risk securitisation. By including insurance risks which are not closely related to economic or political movements, investors can create better performing investment portfolios.

23   It is estimated that about US$2 billion of insurance-linked securities were issued in 1998 and a similar amount in 1999. In Asia, 3 Japanese insurers had turned to the capital market for additional capacity to cover their earthquake and windstorm exposures and two Japanese corporations, Toyota Motor and Oriental Land (Tokyo Disneyland) had also securitised their auto residual value and earthquake risks respectively.

24   It is encouraging to note that the number of insurance-linked securities issued in 1999 had been sustained in a relatively soft market and in the midst of Y2k concerns. In addition, the scope of two innovative catastrophe bonds concluded in late 1999 reflects increasing sophistication of such deals and confidence level of investors over the latest converged product of the insurance and capital markets.

25  One of the deals involved the issuance of a cat bond that bridges the compensation gap for the issuer between a full indemnity transaction and an index-linked deal. It represents an attempt to securitise risk in a manner similar to that of a traditional reinsurance-style indemnity deal without having to disclose details of the portfolio. It thereby sought to address two major reservations about securitisation; namely the burden of basis risk in bonds whose payout is linked to an index which may not closely correlate with the insurer's own underlying exposures, and the need to reveal details of the portfolio of risks to be securitised that could be used by rivals.

26   In another deal which securitised two types of risk in three different regions, we understand that that bond was the first investment-grade catastrophe bond whereby investors could lose the entire principal. Its success shows that investors are growing more confident about the risks they take on.

27   Ultimately, whether insurance-linked securities could gain the level of popularity parallel to that of mortgage-backed and asset-backed securities would depend on whether insurers find that risk securitisation is a cost-effective mean of managing risk compared to the cost of reinsurance or using one's own capital. Investors would have to find that investment in insurance-linked securities would indeed enhance the performance of their overall portfolio and the rates of returns commensurate with the risks assumed.

28   In the opinion of the major market players of this ART product, there is vast potential for insurance-linked securities. By bridging the insurance and capital markets, insurance-linked securities create attractive investment opportunities previously unavailable to those outside the insurance industry. While the cost of such securities may be relatively high in a soft insurance market, over time, such securities can constitute a potential new source of competitively priced insurance coverage, especially at times when the traditional insurance market hardens.

29   MAS is keen to see the structuring and issuance of insurance-linked securities, most probably involving predominately offshore risks, being carried out from Singapore, as it would have a synergistic effect on MAS' effort to develop the capital market. The structuring and issuance of such securities would also broaden our base of financial products, in tune with Singapore's aspiration to be a world class financial centre.

30   While our rules relating to captive business and finite risk reinsurance have been set out, we are still seeking to have a better appreciation of the regulatory implication of insurance securitisation. In this regard, MAS would work closely with the industry and other government agencies as we go about the regulatory review.

Potential of ART in Asia

31   Having taken a look at the global prospect of ART solutions, let us ponder over the potential of ART products in Asia. In considering the Asian landscape, it is important to recognise the disparity of the markets in this region. The forces driving demand for ART products in each country are very different - depending on whether the economy involved is a highly developed one or one of an emerging market.

32   Many Asian insurance markets face the challenge of deregulation and liberalisation. Given the pressure on margins, characteristic of many deregulated and liberalised insurance markets and the considerable volatility of results, there is great potential for cost-effective result-smoothing solutions. With the greater focus on shareholders' value and the change this would bring to the risk management culture, corporations would start to seek financial protection against major swing that can upset shareholder and market confidence, be it caused by insurance or non-insurance risks. Against this backdrop, there is great potential for ART solutions to gain acceptance and popularity in this region.

33   While there is a strong impetus for the proliferation of ART products in Asia, the actual pace of development will depend on how fast the market opens up, how receptive regulators are towards non-traditional products and the ability of Asian insurers to move up the learning curve.

34   MAS would like to have first mover's advantage and be ready to take on this role of a leading ART centre in Asia. We seek to build up a core of reputable and professional service providers in Singapore to provide the full spectrum of activities covering captive insurance, financial reinsurance and securitisation of risks.


35   In conclusion, the prospects of ART products globally as well as in Asia are very promising. New risk financing products will support the continued growth of the ART market and there is likely to be more co-operation amongst insurers/reinsurers and financial institutions to provide integrated solutions to clients. The future will probably belong to those service providers with the requisite know-how, strong financial standing and the ability to provide total risk solutions that create value for their clients. Opportunities call on those who can rethink risk beyond traditional boundaries.

36   With this, I wish you a stimulating and successful conference.

1 Source : Best's Viewpoint, a A.M. Best weekly supplement of 10 April 2000

2 Sigma 2/1999 - Alternative Risk Transfer for Corporations: A Passing Fashion or Risk Management for the 21st Century