Skip to main content
Disciplines
Automotive Business IT + Informatics Construction + Real Estate Electrical Engineering + Electronics Energy + Sustainability Insurance + Risk Finance + Banking Management + Leadership Marketing + Sales Mechanical Engineering + Materials
Events
DE
EN
Books
Journals
Topic Page
Marketing
Start single access now
Access for companies
EXTENDED SEARCH
Log in
Top

2017 | Book

Introduction Read chapter Read first chapter

The Palgrave Handbook of Unconventional Risk Transfer

Editors: Prof. Maurizio Pompella, Prof. Nicos A Scordis

Publisher: Springer International Publishing

Part of: Springer Professional "Wirtschaft+Technik" , Springer Professional "Wirtschaft"

Login to get access
insite
SEARCH

About this book

This handbook examines the latest techniques and strategies that are used to unlock the risk transfer capacity of global financial and capital markets. Taking the financial crisis and global recession into account, it frames and contextualises non-traditional risk transfer tools created over the last 20 years. Featuring contributions from distinguished academics and professionals from around the world, this book covers in detail issues in securitization, financial risk management and innovation, structured finance and derivatives, life and non-life pure risk management, market and financial reinsurance, CAT risk management, crisis management, natural, environmental and man-made risks, terrorism risk, risk modelling, vulnerability and resilience. This handbook will be of interest to academics, researchers and practitioners in the field of risk transfer.

Table of Contents

Frontmatter
1. Introduction
Abstract
The insurance industry has well demonstrated its ability to package risk for sale to capital markets. In 1771 risk underwriters doing business in Edward Lloyd’s coffee house joined in the Society of Lloyd’s. At its most basic, the Society operated by packaging risk into syndicates which then sold layers of that risk to individual investors. The appeal to investors, however, was limited since the practice of the syndicates was to require additional payments, should claims for losses exceed what investors originally bargained for. Beginning in the late 1980s, however, insurers figured out how to package risk for sale to investors in an attractive way. Insurers begun raising capital by selling debt to investors collateralized by receivables on the insurer’s balance sheet. Insurers call such instruments insurance-linked securities (ILS). Monarch Life (now defunct) in 1987 was the first insurer to collateralize receivables from its annuity policies, followed by General American (now a subsidiary of Met Life), and then Prudential with a $445 million issue backed by policyholder loans. American Skandia (acquired by Prudential in 2003) in 1997 issued securities backed with fees from a cohort of variable life policies. In 1996 Hannover Re issued the first catastrophe bond (CatBond) soon followed by a handful of other insurers with a dozen or so issues. At their most basic, CatBonds is debt whose coupon (and even principal repayment) is indexed to the intensity of a naturally occurring event. At the end of March 2016, the outstanding market for CatBonds and other ILS instruments was $26.5 billion worth, with $2.2 billion of new capital issued from ten transactions in the first quarter of 2016.
Maurizio Pompella, Nicos A. Scordis

Risk Management Strategies and Perspectives

Frontmatter
2. A Theoretical Perspective on Risk Management
Abstract
This chapter commences with an analysis of whether a firm should manage risk or not—taking the Modigliani-Miller theorem as a backdrop for understanding when risk management is motivated. We go on to distinguish between risk (randomness that can be described by a probability distribution) and uncertainty (where such a probability distribution does not exist) and discuss consequences of the distinction for risk management. We then turn to different ways of managing risk and uncertainty and first examine hedging with the help of derivatives and insurance, which has been the focus of a large literature. The empirical evidence indicates that this is only one of the many ways used to manage risk, and the rest of the chapter covers alternative means of managing risk and when they are likely to add value: operational hedging, investing in flexibility and ensuring access to liquidity and new funds.
Richard Friberg
3. A Practical Perspective on Corporate Risk Management
Abstract
The essay draws on ideas from across knowledge silos in order to provide a pragmatic examination of the risk management concept in a corporate setting. The essay explores: the need to allow into our thinking the notion that risk and uncertainty are distinct; the practical challenges of implementing the idea that the price of any single risk facing the corporate risk manager also depends on how it associates with all the other risks facing the firm; a tractable strategy for the risk manager given that there is not a consensus on why corporations manage risk. A possible way forward is a management strategy that conceptualizes risk as tactical and as strategic.
Nicos A. Scordis, Annette Hofmann

Conventional vs Unconventional Transfer

Frontmatter
4. Reinsurance, Insurability and the New Paradigms of Unconventional Risk Transfer
Abstract
The true function of the reinsurer is widely misunderstood, even by those working in the financial markets. However, it is a crucial function to give effect to insurance business, which would always be exposed to the possibility that an outstanding loss, or a concentration of accidents, could cause default. This section introduces the traditional insurance and tries to offer an insight into the origins of the unconventional risk transfer, as an alternative to it. Financial innovation in both life and non-life sector is dealt with, and the role of securitisation in the alternative transfer processes is explained. Then we go deep into the enterprise perspective, by redefining the “cost of risk”. The new paradigms of the unconventional transfer and the transition from the Risk Warehousing to the Financial Intermediation approach are illustrated at the end.
Maurizio Pompella
5. Enterprise Risk Management and the Risk Management Process
Abstract
The purpose of this chapter is to discuss the implications of enterprise risk management (ERM) for the risk management process. From my perspective, ERM does not change the major steps in the traditional risk management process; instead, ERM encourages organizations to take a broader perspective and carry out a deeper analysis in each of the steps in the risk management process. More specifically, I argue that an ERM approach (1) places more emphasis on value creation as an objective of risk management, (2) emphasizes the identification of all major risks facing an organization, regardless of how they are categorized, (3) seeks to assess the aggregate risk facing the organization, and (4) considers a larger and more innovative set of methods/contracts to treat risk.
Greg Niehaus
6. Credit Risk Transfer with Single-Name Credit Default Swaps
Abstract
Credit default swaps (CDSs) are the primary type of derivatives contracts with which market participants can protect themselves against the risk of a default by one or more underlying reference entities. We explore the recent market activity in CDSs, as well as the mechanics of CDSs, including documentation, triggering credit events on underlying reference entities, and settlement methods. We also explain how CDSs can be used to facilitate credit risk transfer.
Christopher L. Culp, Andria van der Merwe, Bettina J. Stärkle

Risks by Class

Frontmatter
7. Natural Hazards
Abstract
This chapter explains the basic physical sciences of key natural hazards. It states how the different hazards are defined and categorised, where and when the hazards occur and what secondary hazards are associated with the primary hazard. The chapter provides a brief overview of what is known and unknown and discusses some of the current uncertainties related to modelling the frequency and severity of events. It further introduces some of the physical and social vulnerabilities associated with these perils and potential mitigation techniques. Hazards covered include geophysical hazards (earthquake, volcano, and landslides), hydro-meteorological hazards (tropical cyclones, tornadoes, tsunami, and flood), and extraterrestrial hazards (impactors and space weather).
Joanna Faure Walker
8. Anthropic Perils and Man-Made Risks
Abstract
A hall-mark of the twenty-first century is global technological advancement. The welcome positive rewards of modernization are however associated with some negative outcomes: risks of industrial failures and disasters, as well as major transportation accidents on land, sea, air and in space. The fifth societal dimension is cyberspace, which is an expanding domain of human endeavour, inevitably accompanied by cyber crime. Economic losses from these man-made risks can be transferred through some type of insurance facility. The intersection of politics and violence is terrorism, which is another universal anthropic peril that is amenable to modern financial risk management. A general review of anthropic perils and man-made risks is presented.
Gordon Woo
9. Mortality and Longevity Risk
Abstract
This chapter examines the insurance and pension-related risks arising from the uncertainty of human life-length, which constitute the most important part of a major class of insurance risks sometimes referred to under the umbrella term biometric risks. Mortality risk results from differences between observed and expected mortality rates in an insured population. By contrast, longevity risk is related to the phenomenon of increasing average human lifespans, and tends to affect government pension systems, defined-benefit pension schemes, and life insurers writing annuities. In this chapter, we give an overview of these risks along with their place in the Solvency II framework, to be followed by a detailed presentation of available quantitative risk assessment methodologies and traditional risk management solutions. Finally, we conclude with a brief introduction to the promising alternative risk management framework of mortality-linked securities.
Erzsébet Kovács, Péter Vékás
10. Country Risk: Case Study on Crises Examples and Lessons Learnt
Abstract
Country risk has a great influence on the intensity of international business and capital flow. It is considered either as the risk or Sovereign default or as the risk for portfolio or foreign direct investment. Among country risk sources, analysts often mention inadequate monetary or fiscal policy, wrong treatment of property rights, high sectoral concentration and dramatic changes in the external environment. But it might also happen that some or even all of these risk factors appear simultaneously. As a result, country risk leads to financial crisis that realizes through the so-called ideal storm. In the chapter, we will consider particular cases of country risk generation and management in different countries to show how similar they are in terms of country risk sources.
Vasily Solodkov, Yana Tsyganova

Vulnerability, Market Solutions and Societal Implications

Frontmatter
11. Disaster Vulnerability
Abstract
The concept of vulnerability is essential when aiming to understand the societal construction of disasters. However, definitions and concepts vary between different research fields and disciplines. The concept of vulnerability can explain why similar hazards and extreme events, such as severe earthquakes, storms or floods, can have quite different adverse consequences for different communities, societies and infrastructures exposed and impacted. Examining differential vulnerabilities within disaster risks is key when aiming to develop strategies for disaster risk management and adaptation to extreme events. The discourse of disaster vulnerability has not developed within a very coordinated way; rather, vulnerability has emerged within different schools of thought, and solely in the past two decades, major integration and cross-coordination have taken place. This chapter outlines selected concepts and definitions of vulnerability and examines the nexus between vulnerability and urbanisation.
Joern Birkmann, Linda Sorg, Torsten Welle
12. Insurance-Linked Securities: Structured and Market Solutions
Abstract
The traditional reinsurance markets face capacity limits. Global financial markets provide a much larger pool to diversify large (re)insurer risk. Insurance-Linked Securities (ILS) are a group of financial instruments, which are sold to institutional investors and whose value is affected by an insured loss event. ILS encompass multiple forms of risk-linked securitization such as CAT bonds, weather derivatives (WDs), contingent capital (CC), and Finite Re products. Their purpose is to provide more efficient ways to transfer large-scale risk by combining insurance and reinsurance techniques with capital market techniques.
Annette Hofmann, David Pooser
13. Longevity Risk Transfer
Abstract
Longevity is one of the greatest risks threatening the stability of our society. An anti-ageing breakthrough that slowed down our biological clocks would cause profound challenges for our society, particularly if it was a quick and cheap intervention. The adjustment would be difficult for politicians: many countries operate pay-as-you-go state pension systems, with the current generation of workers paying for the pensions of the retired generation. Increased expectations of life expectancy require tax rises, later retirement ages or cuts to pensions in payment. The unpopularity of this economic medicine is believed to be one of the reasons why governments have habitually underestimated the scope for improvements in life expectancy, so we are currently playing catch-up with belated increases to state pension ages. The lack of preparedness for further increases in life expectancy risks could trigger a global economic recession, with the natural reaction of older people being to hoard their savings, causing a reduction in consumer demand. So, there is both an opportunity and a need for innovation to build corporate and societal resilience to longevity risk. Valuable lessons are being learned from the development of other exotic commodities—like credit risk and catastrophe bonds—to shape the new longevity trading market. In this chapter, we explore sources of longevity risk; properties of longevity risk; why organisations wish to cede longevity risk; why organisations wish to acquire longevity risk; how longevity risk is currently transferred; the lessons learned from the journey to date; and the future for longevity risk transfer.
Douglas Anderson, Steven Baxter

Risk Modelling and Stress Testing

Frontmatter
14. Quantitative Man-Made Risks’ Modelling
Abstract
Catastrophe modelling began with earthquakes, then expanded to cover windstorms, floods, tsunamis, volcanic eruptions and other natural hazards, and has evolved in the twenty-first century to cover significant man-made risks like terrorism, and cyber crime. The modelling of man-made risks is reviewed, with particular attention given to the principles of terrorism risk modelling. Pandemic risk is also covered because of its historical linkage with political risk. The application of man-made risk modelling to financial risk transfer is discussed.
Gordon Woo
15. Pandemic Risk Modelling
Abstract
This chapter will explore the nature of communicable diseases, a brief history of pandemics, and will introduce the mathematical models used to evaluate the risk pandemics pose to human populations. Such modelling is used in a public health context, where modelling past and current events provides insight in how to respond most effectively to a new outbreak. It is also used in the context of risk mutualisation and transfer. As recently as 2013, a survey of 30,000 insurance executives placed global pandemic as the biggest extreme risk facing insurers (Towers Watson. 2013. Insurers Rate Global Pandemic as the Major Extreme Risk. 3 December). The chapter will introduce the principles used to model these events in the insurance industry and will conclude with a review of the way these models are applied in an unconventional risk transfer context.
Dominic Smith
16. Assembling Individual ILS into an Optimal Portfolio
Abstract
Much has been written about individual insurance-linked securities (ILS), a.k.a. Cat Bonds, in the 20 years of their existence. This includes pricing, investor returns, liquidity and their advantages/disadvantages to investors—they provide good returns and excellent diversification. Much less has been written about how individual ILS should be assembled into an optimal portfolio. We seek to address that question—how do you underwrite (i.e., assemble) a portfolio of ILS that maximizes return and does not take excessive risk. Traditional reinsurance underwriters used to contain the excessive risk question by a “silo-ed” approach to selecting different risks. Nowadays, more sophisticated approaches are available. In the capital market modern portfolio theory (MPT) or mean-variance optimization (MVO) is used to select high return assets that are not highly correlated so as to have a portfolio of low variation. This requires knowledge of correlation and covariance of assets as well as an assumption of log normality of return. In insurance and ILS in particular, such covariance measure are not forthcoming and, more important, returns are not normal—but long tailed. Instead, in this chapter, we use a scenario approach and stochastic optimization in which the co-movement of outcomes is captured implicitly via each scenario, rather than explicitly via correlation coefficients. The portfolio is optimized over all scenarios, subject to pre-specified risk constraints.
Morton Lane
17. Stress Testing with Bayesian Nets and Related Techniques: Meeting the Engineering Challenges
Abstract
The chapter briefly reviews the case for stress-testing risk models and recognizes the pressing ‘engineering’ problems that stand between the concept of stress testing and actually doing so for a risk model, such as a portfolio that includes a supposedly optimal allocation of assets. The chapter argues that the application of the Bayesian net ‘technology’ to stress testing introduced in the last decade lends itself particularly well to the need for a practical way to stress-test risk models. The chapter presents proposed solutions to the challenges of stress testing a model with particular reference to the use of Bayesian nets.
Riccardo Rebonato
Backmatter
Metadata
Title
The Palgrave Handbook of Unconventional Risk Transfer
Editors
Prof. Maurizio Pompella
Prof. Nicos A Scordis
Copyright Year
2017
Electronic ISBN
978-3-319-59297-8
Print ISBN
978-3-319-59296-1
DOI
https://doi.org/10.1007/978-3-319-59297-8