Insurance risks

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Insurance is big business – gross premiums in OECD countries totalled US$2,510 billion in 2000, a 6.4% increase from a year earlier, almost half of it concentrated in the US with a market share of 45.6%. If you take out life insurance, the US share of the US$1,087.2 billion market is even larger, at 56.2%. The people and businesses paying these premiums are buying a guarantee that they will be cushioned against risk, whether it be loss of their most precious possessions in a burglary, death in an accident or the destruction of a factory building by fire, flood, or deliberate attack.

But how do insurers deal with their own risks, to ensure that they can meet an unexpectedly high number of claims due to events such as 11 September or the worst flooding in a century? One longstanding answer is reinsurance, where insurers borrow off-balance sheet capital to reduce pressure on their own risk-bearing capital.

But after a series of major catastrophes, a shortage of major funds can drive up the price of acquiring capital in the reinsurance market. This happened in the United States in the wake of Hurricane Andrew and the Northridge earthquake in the mid-1990s, and insurers turned to insurance-linked securities.

Demand for these stagnated in the late 1990s as reinsurance premiums fell, but market participants expect the events of 11 September to send demand for insurance-linked securities rising again, particularly “catastrophe bonds” covering predefined natural catastrophes such as an earthquake or hurricane.

OECD, 2002, Financial Market Trends, Finance and Investment, No. 82, Paris 2002

OECD, 2002, Insurance Statistics Yearbook 1993-2000, Paris 2002

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