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DOOMSDAY AND REINSURANCE PART DEUX

DOOMSDAY AND REINSURANCE PART DEUX. ERNST N. CSISZAR DEPARTMENT OF INSURANCE STATE OF SOUTH CAROLINA. A RECAP OF PART ONE. WHAT IS SYSTEMIC RISK? Confidence and interdependence WHY WORRY ABOUT SYSTEMIC RISK? Source of potential financial crises WHO WORRIES ABOUT SYSTEMIC RISK?

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DOOMSDAY AND REINSURANCE PART DEUX

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  1. DOOMSDAY AND REINSURANCEPART DEUX ERNST N. CSISZAR DEPARTMENT OF INSURANCE STATE OF SOUTH CAROLINA

  2. A RECAP OF PART ONE • WHAT IS SYSTEMIC RISK? • Confidence and interdependence • WHY WORRY ABOUT SYSTEMIC RISK? • Source of potential financial crises • WHO WORRIES ABOUT SYSTEMIC RISK? • The Financial Stability Forum and others

  3. WHY WORRY ABOUT SYSTEMIC RISK IN THE RE INSURANCE SECTOR? • The recent involvement of reinsurers with other financial institutions • WHAT CAN BE DONE ABOUT SYSTEMIC RISK? • Policy development and crisis prevention, containment, and management

  4. SYSTEMIC RISK - THE CONTINUATION • What factors drive the continuing concern about insurance and reinsurance as sources of systemic risk? • “The house of cards” scenario • “The perfect storm” scenario

  5. The house of cardsReinsurers and credit markets • Credit transfer between insurers / reinsurers and other economic sectors • The effect of slumping global stock markets in investment portfolios of reinsurers • The downturn in corporate credit markets • Defaulting bonds e.g., Worldcom, Enron etc. • Exposures through commercial surety bonds

  6. The international payments settlement process • Loss of faith in financial system • Fear of system-wide default

  7. The structure of credit-related products: • Credit enhancements • Credit derivatives e.g., credit default swaps • Collateral debt obligations e.g., guarantors and investors • The impact of credit downgrades

  8. The issues • Naïve capital • Risk concentrations • Financial contracts versus contracts of good faith • Fiduciary aspects • Disclosure requirements • Proof of loss • Contested contracts • Reinsurance culture vs. financial institutions’ culture: contest now and pay later vs. pay now and contest later

  9. The problem: • No one knows • Opaque transparency • Inadequate disclosure • Lack of oversight

  10. The perfect stormReinsurers and the real economy • Insurance as a “foundation” industry • The “glue” of our economy • Global capacity at a 1999 high based on $720 billion in capital and surplus • Global financial performance of the industry • 25% loss of capital and surplus in 2001 and 2002 • Poor underwriting results • Poor investment results • Inverted risk / return relationship

  11. Causes: • Self-inflicted wounds • 1980 – 2002: $439 billion in underwriting losses • Recent dismal investment results • Catastrophes • $100 billion in last three years • Asbestos claims • $160 billion

  12. Liability exposures • Product liability and medical malpractice losses • New risks • Toxic mold and information technology risks • Further terrorist activities

  13. What can be done to improve performance? • Further reduce capital • Reduce risk • Improve net profits, particularly from underwriting operations • Public and regulatory resistance to higher rates • Financial rating downgrades THE PERFECT STORM! • A REAL NEED FOR NEW CAPITAL

  14. THE WORK OF THE IAIS AND FSF • Disclosure and transparency • Task Force Re • Development of a database for reinsurers

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