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Mag. Monika Gruber o.Univ.-Prof. Dr. Matthias Bank Department of Banking and Finance,

Alternative risk transfer mechanisms against the background of the Austrian legal framework – a suggestion for improvement. Mag. Monika Gruber o.Univ.-Prof. Dr. Matthias Bank Department of Banking and Finance, Leopold-Franzens Universität Innsbruck, Austria in collaboration with:

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Mag. Monika Gruber o.Univ.-Prof. Dr. Matthias Bank Department of Banking and Finance,

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  1. Alternative risk transfer mechanisms against the background of the Austrian legal framework – a suggestion for improvement Mag. Monika Gruber o.Univ.-Prof. Dr. Matthias Bank Department of Banking and Finance, Leopold-Franzens Universität Innsbruck, Austria in collaboration with: alpS GmbH – Centre for natural hazard management, and Hypo Tirol Bank AG, Austria

  2. Alternative Risk Transfer (ART) • ART & ARF • Risk transfer & Risk financing (self-insurance & risk retention) • Insurance & Capital markets (convergence) • Alternative because traditional financial products are applied to insurance issues, or vice versa • Supplement to traditional insurance • Standardisation and individualisation (tailoring) • Multi-year, Multi-line, Multi-trigger • Participation in positive loss experience • Main field of application: natural catastrophes, liability, terrorism

  3. Alternative Risk Transfer (ART) Risk Transfer ibs Retention Risk Transfer ipm Risks are retained in the company: DEDUCTIBLE & FINANCE Risks are transferred to another corporate entity: TRANSFER Unfunded Post-loss Financing Funded Pre-loss Financing • Traditional Insurance • Securitisation: Bonds & • InsuranceDerivatives • Insuritisation • Integrated Risk • Management Risk Finance • Self-insurance • Captives • Contingent Capital • Finite Risk Solutions Risk Transfer ( ART): Risk Finance (ARF) & Risk Transfer in its proper meaning (ipm) • ART & ARF Risk Finance ( ARF): Funded Retention, Self-insurance, Provision of funds “ex ante“

  4. Reasons for ART • ART & ARF • Reasons for • ART • Un-insurable risks: natural hazard, terrorism risk, technological risks • Relatively high frequency and intensity of natural and technical catastrophes, climate change • High population density, e.g. Tirol (Austria) 445 inh./km2 (2004) High-quality building materials  additional insurance cover needed • Insurance industry provides no/limited cover for certain risks • Lack of insurance (capacity, supply, demand) • Responsibility of the government? e.g. catastrophe funds, monopolistic/compulsory insurance • Need for alternative solutions …

  5. Reasons for ART - Austria • ART & ARF • Reasons for • ART Limited Coverage for Property insurance against natural hazards: Business Insurance: Business interrruption, fire, theft, storm and certain natural hazards, liability, property etc. Combined business policies Additional catastrophe cover up to € 150.000 per event !! Cumulation Clause: If the insurer‘s total claims exceed max. € 30 Mio., the damage compensations will be paid aliquotly.

  6. Reasons for ART • ART & ARF • Reasons for • ART Why is there a lack of insurance? Difficult and expensive risk simulations necessary for proper insurance of low frequency – high severity risks Consequently premium calculation problematic High cost of reinsurance of certain risks Low demand for cover against natural hazards (?): “A once-in-a-hundred-years event is expected to occur once in a hundred years. So, why insure after the occurrence of such event?” No capacity on the (Re-)Insurance market

  7. Reasons for ART • ART & ARF • Reasons for • ART … Why is there a lack of insurance? Reinsurers’ interest: limited supply of cover  higher premium, less risky portfolio  higher equity returns  shareholder value maximisation Agency issues, moral hazard, adverse selection Governmental Intervention – public funds e.g. Austrian Catastrophe Fund with approx. € 250-400 Mio. annual compensation capacity (already insufficient after flood 2002 and 2005) e.g. Austrian Terror Pool – conjoint damage compensation through Austrian insurance companies up to € 200 Mio., no state guarantee

  8. ART mechanisms • ART & ARF • Reasons for • ART • ART • mechanisms

  9. The Austrian Legal Background (I) • ART & ARF • Reasons for • ART • ART • mechanisms • Legal • Background Insurance Market Regulations • EU-Directives Solvency I+II: solvency margins, capitalisation, capital structure, etc. • EU-Directives on European Reinsurance and Insurance Broking: capitalisation of captives, regulation of fronting, etc. • International Financial Reporting Standards: differences particularly regarding the accounting treatment of financial instruments, etc.

  10. The Austrian Legal Background (II) • ART & ARF • Reasons for • ART • ART • mechanisms • Legal • Background Taxation and Accounting Issues • Insurance Tax (§1 VersStG) captives, RRGs • Corporate Income Tax (§ 26 BAO, § 18/1 Z 2 EStG) financial and insurance derivatives, deductibility of insurance premiums (captives, finite risk reinsurance)  US-IRS statements • Capital Gains Tax (KESt) derivatives, weather derivatives, cat bonds, finite risk (re-)insurance, contingent capital, captives • Regulations concerning accounting practices (öHGB, IFRS) e.g. capital reserves and provisions all ART instruments

  11. The Austrian Legal Background (III) • ART & ARF • Reasons for • ART • ART • mechanisms • Legal • Background Insurance Market Surveillance (e.g. VAG) • Requirements for the establishment of insurance companies in Austria (e.g. capital stock) captives, RRGs, pooling arrangements • General insurance terms and conditions (AVB) finite risk (re-)insurance, insurance derivatives, captives, etc. • Insurance contract law (VVG) finite risk (re-)insurance, insurance derivatives, captives, etc.

  12. The Austrian Legal Background (IV) • ART & ARF • Reasons for • ART • ART • mechanisms • Legal • Background Additional Legal Issues • Public funds and support in case of catastrophes (KatFondsgesetz 1996, Tir KatHilfsdienstgesetz) • Regional planning, hazard zone planning (GZP-VO, TROG, ForstG, TBO) • Proposal for a Directive of the European Parliament and the Council on the assessment and the management of floods 2006  HORA: information system regarding property risk profiles, generalized basis for insurance pricing in Austria, already established as part of the future implementation of the mentioned Directive

  13. Critical Issues – ART implementation • ART & ARF • Reasons for • ART • ART • mechanisms • Legal • Background • Implementation • Issues • Premium deductibility to be clarified by (inter)national jurisdiction • Additional provisions for insurance and capital market surveillance on national, European and international level • Harmonisation of market regulations in order to increase transparency and enhance fair pricing on insurance and capital markets e.g. capitalisation, solvency margins, reporting requirements and standards

  14. Critical Issues – ART implementation • ART & ARF • Reasons for • ART • ART • mechanisms • Legal • Background • Implementation • Issues • Public-Private Partnership for more efficient risk sharing and risk reduction • Assessment of critical market volumesand target groups in Austria, in particular concerning captive formation and individualised contracts as e.g. weather derivatives • Creation of a risk reducing culture including improved risk perception – improving individual risk responsibility

  15. Thank you! For additional information please contact Monika.Gruber@uibk.ac.at

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