Now that the time to start inputting data for the major legal directories has come round again (for most of us, at any rate) there again will be discussion as to whether alternative risk transfer (ART) has matured sufficiently to be an independent practice area in the directories. ART is undoubtedly developing, but it has yet to be recognised that, were accurate statistics available, the proportion of "alternative" premium written compared to traditional premium written would be so small as to hardly feature on a bar chart. As noted in a perceptive feature in The Lawyer (27 November 2000), though, ART is advancing and its progress is likely to pick up momentum.
Denton Wilde Sapte first commissioned a report on trends in ART and financing in the summer of 1999. Then there was an expectation of substantial further growth in the catastrophe bond market, where the survey found that demand outstripped supply. It was expected that in the wake of that growth there would be the start of non-catastrophe securitisation. The market was perceived to prefer bonds over swaps, since the bond proceeds in hand had the advantage over relying on unfunded covenants in the swaps arena. The fastest growth area was that of finite products followed by credit products.
In new research the firm reappraised the current state of play in ART. While the fastest growth has indeed occurred in finite and credit products, various new research indicates that there has been a tailing off of bonds issues. The predicted debut of non-catastrophe bonds failed to materialise. Derivative-based products have also made less headway than expected.
The expected upward trend in traditional insurance rates has been slower to show itself than expected. Consequently, the possibility that traditional covers at sensible rates might not indefinitely be available has receded. It was largely this fear that motivated the more forward-thinking parts of the industry to seek alternative solutions. It was recognised that the development of alternatives would be time-consuming, involving teams of professionals examining (often cross-border) tax, regulatory and accounting issues. There was and is an awareness that should the current buyers' market suddenly become a sellers' market, it would be too late at that point to start attempting to work out radical ways to overcome the problem. Progress, though, has been made quite quickly in developing products that are capable of serving as alternatives to traditional insurance covers.
A particular area of growth at present is financial guarantee. There is evidence that a number of insurers and reinsurers view financial guarantee as a potentially profitable use of capital at a time when premium rates in many lines of business are depressed. This seems to be an opportunity that the Lloyd's market is keen not to miss out on. Lloyd's is, however, adopting a cautious approach to the expansion of its permitted financial guarantee business: it has identified the need for syndicates to take on people with appropriate underwriting expertise and has set attributable funds at a high level. Some may say that this level has been set so high as to present a competitive disadvantage to the Lloyd's market. Presumably the intention is to see how a carefully managed expansion of this class of business performs and to look at the possibility of introducing modest relaxations in terms of committed capital if experience shows that reductions can be justified.
ART transactions tend to be heavily protected by confidentiality, so it is impossible to gauge accurately how many transactions are being done or by whom. However, a considerable volume of interesting work is undoubtedly going on. Although the focus of a portfolio of ART work in progress will often shift, there are plenty of interesting transactions happening at any given time in this area of hybrid legal, regulatory and accounting products.
George Sandars is a corporate partner at Denton Wilde Sapte.