UNDERWRITING CAPACITY

Since it is a new class of business for the insurance world, insurance capacity is restricted, mainly due to the relatively small capital base of the insurance world, but also because of the limitation arising from the overall diversification (risk accumulation control), and the time the buildup phase of a portfolio of similar risks takes.

Another factor is the new experience and know-how that has to be collected and built up over a certain period.

In addition, recent developments on the financial markets and their impact on insured private equity portfolios can now be compared with collected underwriting information from the past, and corresponding expected results and developments.

The insurers will not only consider their exposure assumed from insuring alternative asset classes, but will use a consolidated view of insurance risk and investment risk in the same underlying alternative asset class, which may lead to further restrictions.

Since September 11th, a huge amount of insurance capacity has been destroyed and the price for any capacity left has increased dramatically in addition to the previous capacity restrictions. This has an impact on the attractiveness of insuritized solutions. With higher insurance premiums the economic benefit to the investor is reduced, resulting in a natural upper limit independently of the price for insurance capacity in general.

The challenge for the architect of a deal is to optimize the use of the insurance capacity available (be it in-house capacity or from other markets through co-insurance or retrocession) and to use substitutes in the construction of such structures wherever possible.

Such substitutes contain different combinations of insurance techniques (layering, retrocession, finite reinsurance, combination of risks and of asset classes, decomposition of the risk into systematic and non-systematic risks and the respective hedging of the systematic part of it).

This situation changed dramatically last year, when one of the major rating agencies came up with the necessary techniques and models to provide a rating on a private equity backed securitization. The ability to have such products rated broadens the variety of additional capacity providers. This includes, but is not limited to, companies whose restrictions require product ratings (such as the credit monoline market) or the opening up of the financial markets with capacity and capital creation techniques such as securitizations.