Assured futures

Another bumper year for Bermuda. David Lines looks at the latest innovations. David Lines is a solicitor at Appleby Spurling and Kempe in Bermuda. For Bermuda's ever-growing international business sector, 1995 and 1996 proved to be bumper years. 1997 is also showing signs of being a substantial year of growth. While Bermuda continues to build on its strengths as a premier offshore jurisdiction, it is also exploring new and exciting areas of development.

Bermuda's growth is characterised by the number of new foreign-owned companies incorporated there. Between July 1996 and June 1997 over 1,000 foreign-owned companies set up in Bermuda. Its strongest market, insurance, has also seen considerable growth. During the 12 months to December 1996, 97 insurance companies were incorporated in Bermuda. The Registrar of Companies figures show 1995 as a record year, with net premiums growing to $18.4bn compared with $14.9bn in 1994.

Bermuda's continued growth has enabled it to develop new and innovative markets. The Catastrophe Risk Exchange (Catex Bermuda) and the Bermuda Commodities Exchange (the Exchange) are two such examples.

Upon inception, Catex Bermuda will be the world's first offshore, computer-based risk exchange where members may cede, exchange or purchase risk electronically. It is intended to provide a means for primary insurers and reinsurers of property risks access to an electronic exchange allowing them to diversify their portfolio of perils at a lower cost and diluting their overall risk exposures.

The guiding principle of Catex Bermuda is that catastrophe risk will be exchanged on a risk-for-risk, or risk-for-premium basis. In essence, it will allow insurers and reinsurers to trade risks with other parties which have written risks in different geographic locations and insured property against a variety of different perils. In practice, it will provide for the execution of reciprocal reinsurance contracts, or “risk swaps”, whereby two risk bearers will assume partial, reciprocal liability for a defined component of each others' risk.

For example, one company may cede $50m in Florida windstorm exposures to another reinsurer, and assume in return $100m of midwestern tornado exposure. The amount on each side of the trade, the specific perils and the regions involved can all be negotiated. Trades will then be registered with Catex Bermuda.

The Bermuda Stock Exchange expects Catex to begin trading in the first half of 1998.

Unlike Catex, the Bermuda Commodities Exchange seeks to provide a market for insurers and reinsurers to cover a portion of their risks arising from their writing of insurance or reinsurance policies. In doing so, the Exchange hopes to initially provide an additional $500m of capacity for US atmospheric perils, primarily wind.

The Exchange is a fully-automated electronic exchange – the electronic equivalent of “open-outcry” trading (traders in brightly coloured jackets screaming and gesticulating at each other), with the exception that trading members' identity is confidential. The options are similar to any other option requiring both a seller and purchaser. The purchaser will negotiate with the seller to arrive at a non-refundable purchase price referred to as a premium. Each option will be written with a specific strike price and become payable only when the Index, on which the option is referable, meets or exceeds the strike price. It should be noted, however, that an option is not a contract of indemnity and does not cover losses incurred by a reinsurer.

Each type of option offered by the Exchange will represent $5,000 of coverage and will require the seller of the option to pay to the purchaser $5,000 if the level of the relevant Index at the time the option settles is at or above the strike price. An option will cover a six-month “risk period”. Options will be issued with respect to each region for which an Index is published, and the Index will only reflect insured home-owner property damage arising from windstorm, hail and freezing, excluding losses relating to fire, flood, earthquake, explosion and riots.

The central feature for the success of the Exchange is the correlation between the Index (for each region) and the actual losses incurred by a reinsurer. The Exchange is optimistic about the success of the Index which is determined by collecting exposure and paid loss information from pre-selected insurance companies at the zip code level in the particular regions covered by the options.

The Exchange hopes that the vast statistical data on which the Index is based will ensure that actual losses incurred by a reinsurer will significantly correlate to movements in the Index. The Exchange expects trading to begin on 12 November 1997.

Due to the innovative nature of both Catex and the Exchange, these markets will take time to develop. They are, however, a logical extension of Bermuda's role as the leading offshore jurisdiction.