As many of us would remember, about 10 years ago, we learned a lesson. The world learned that repackaged mortgage loans, renamed ‘collateralised debt obligations’ spelled trouble. Lest we forget, these CDOs played a major part in the collapse of financial institutions, beginning in 2007. They gave a bad rap to the word ‘derivatives’.
Some critics believe that bundled risks, in the name of better risk management, have caused the reinsurance market to become so complex that it is very difficult to determine what is going on. Put another way, do bundled deals obscure underlying risks? Most reinsurance experts deny this, but that doesn’t mean we shouldn’t pay close attention.
The entire concept of reinsurance is a very worthwhile one that has stood the test of time. How we protect ourselves from the cost of natural disasters is of vital importance particularly in light of the climate change issues that are being debated at the United Nations, and by the OECD in Paris.
Marine reinsurance, which has comfortably covered losses around the world for over a century, has changed in recent years. The age of the specialist is largely over; where the problem arises for the shipping industry is that its particular risks, which can range from an oil platform explosion to, potentially, a cruiseship fire, are now customarily combined with non-maritime disasters, such as a tsunami combined with the flooding and breakdown of nuclear power plants in northern Japan. This combination of cross‐border packaging may present hidden risks.
Insurance is global in its perspective, and is now dominated by massive companies, that price risks according to a worldwide pattern of supply and demand. As consolidation has become the rule, the number of reinsurers handling these diversified products – including maritime risks – has been reduced. A major ‘hit’, or group of massive losses, is not unthinkable. Reinsurance companies are not diversifying their risks, but rather concentrating them. The effect of very large packages of insured risks may make them more vulnerable to a big natural shock.
Some observers believe that it is important to clarify whether there is truly a ‘reinsurance market’, and that it would be wise to impose a series of strenuous ‘stress tests’ on these concentrated risks facilities.
As one critic has said: “It’s always better to learn from prior knowledge than it is from bitter experience.”