By Thomas A. Player
The capacity of the capital markets to fund securitizations is far greater than either the direct insurance market capacity or the worldwide reinsurance capacity (see Figure 1). My estimates of the frictional cost of accessing the capital markets is much less than the frictional costs for either of the other two (see Figure 2). That fact alone should drive more insurance risks into the capital markets than has occurred historically.
Securitizations have been on the rise, particularly in specialized situations such as CAT risks and redundant life reserves, but securitizations of core insurance risks continue to be slow in implementation. However, just recently, Munich Re announced its first ever mortality bond, shifting $100 million of its pandemic event risk to the capital markets. This is said to be the first of a $1.5 billion program to transfer extreme mortality risk to the capital markets.
That was before the subprime mortgage meltdown.
It is certainly too early to predict the effect of the meltdown on the insurance industry and its ability to access the capital markets in the future. However, three things seem certain.
- There will be investigations. Currently, many state Attorneys General have launched both investigations and lawsuits. In addition to the FBI and the Securities and Exchange Commission, state Attorneys General in Arizona, Texas, Connecticut, Illinois, Massachusetts, Florida, Iowa and Ohio have taken action, just to name a few. Civil actions have been filed by Massachusetts and Ohio. There are inquires into fraud and impropriety in the organization of the mortgages, the sale of the mortgage-backed securities and the suitability of mortgage-backed securities for certain investors.
- There will be legislative fixes (both state and federal). Already the American Securitization Forum (ASF) and the Securities Industry and Financial Markets Association (SIFMA) have emphasized the importance of a sensible regulatory response to the challenges of the subprime mortgage finance market. The organizations note that a measured, reasonable approach at the federal and state level is imperative for liquid, efficient and well-functioning national mortgage securities markets. One focus of legislation certainly will be strengthening consumer disclosure laws. Another potential area of legislation would require more disclosure and structural boundaries in the sales of mortgage-backed securities.
- There will be innovations. We have already seen evidence of innovation in Warren Buffet’s sponsoring of a de novo financial guarantee insurer, which enjoyed fast-track licensing by the New York Department of Insurance under the urging of Superintendent Dinallo. The NAIC is helping to expedite licensing for Berkshire Hathaway Assurance Corporation by utilizing its Uniform Certificate of Authority Application.
Just as with hurricanes Katrina and Rita, many lost much in catastrophic losses; however, others gained much in the aftermath of the storms as fresh capital filled the voids. Could we see the same phenomenon in the aftermath of the subprime meltdown where fresh capital will fill the need for financial guarantee writers, and fresh regulations will provide greater stability and predictability in the securitization markets? The ultimate result might be that the insurance industry gains more access to the abundant, efficient capacity available in the capital markets.
Thomas Player is a senior partner in the insurance and reinsurance group. His areas of expertise include insurance and reinsurance, mergers and acquisitions, complex regulatory issues and dispute resolution. Tom received his bachelor’s degree from Furman University and his law degree from the University of Virginia.
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