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CATASTROPHE BONDS: SPREADING RISK

HEARING

BEFORE THE

SUBCOMMITTEE ON

OVERSIGHT AND INVESTIGATIONS

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

OCTOBER 8, 2002

Printed for the use of the Committee on Financial Services

Serial No. 107–86

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Texas

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

SUE W. KELLY, New York, Chair

RON PAUL, Ohio, Vice Chairman

PETER T. KING, New York

ROBERT W. NEY, Texas

CHRISTOPHER COX, California

DAVE WELDON, Florida

WALTER B. JONES, North Carolina

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

ERIC CANTOR, Virginia

PATRICK J. TIBERI, Ohio

LUIS V. GUTIERREZ, Illinois

KEN BENTSEN, Texas

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

MICHAEL CAPUANO, Massachusetts

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missouri

(III)

C O N T E N T S

Page

Hearing held on:

October 8, 2002 ................................................................................................. 1

Appendix:

October 8, 2002 ................................................................................................. 29

WITNESSES

TUESDAY, OCTOBER 8, 2002

Brynjolfsson, John, Executive Vice President, PIMCO ........................................ 16

D’Agostino, Davi M., Director, Financial Markets and Community Investment, General Accounting Office (GAO) accompanied by Bill Shear .............. 4

McGhee, Christopher M., Managing Director, Marsh & McLennan Securities

Corporation on behalf of the Bond Market Association .................................... 14

Moriarty, Michael, Director, Capital Markets Bureau, New York Department

of Insurance on behalf of the National Association of Insurance Commissioners ................................................................................................................... 6

Ozizmir, Dan, Senior Managing Director and Head of Trading, Swiss Re

Financial Products ............................................................................................... 18

APPENDIX

Prepared statements:

Kelly, Hon. Sue W. ........................................................................................... 30

Oxley, Hon. Michael G. .................................................................................... 32

Brynjolfsson, John ............................................................................................ 33

D’Agostino, Davi M. .......................................................................................... 56

McGhee, Christopher M. .................................................................................. 64

Moriarty, Michael (with attachments) ............................................................ 72

Ozizmir, Dan ..................................................................................................... 215

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

‘‘Catastrophe Insurance Risks’’ The Role of Risk-Linked Securities and Factors Affecting Their Use, General Accounting Office Report ............................ 219

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CATASTROPHE BONDS: SPREADING RISK

Tuesday, October 8, 2002

U.S. HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATION,

COMMITTEE ON FINANCIAL SERVICES,

Washington, D.C.

The subcommittee met, pursuant to call, at 2:08 p.m., in Room

2128, Rayburn House Office Building, Hon. Sue Kelly [chairman of

the subcommittee] presiding.

Present: Representatives Weldon, Tiberi, and Inslee.

Chairwoman KELLY. [Presiding.] Good afternoon. In the interest

of time, I am going to go ahead and start this hearing. I understand there are other members that are on their way down, but I

am going to go ahead and start because you have all come—a few

from some distance, and I want to be able to get you fully heard

before we end this hearing. So this hearing of the Financial Services Committee, Subcommittee on Oversight and Investigations will

come to order. I want to thank all members of Congress who will

be coming today. Without objection, all members present will participate fully in the hearing and all opening statements and questions will be made part of the official hearing record. The chair recognizes her self for a brief opening statement.

Let me first say welcome to what will likely be the last hearing

of the Financial Services Committee for the 107th Congress. It

would be an understatement to say that this committee has been

busy. I know our staff agrees, and I want to take this opportunity

to publicly thank the remarkable and very professional staff of the

Financial Services Committee for their work this year.

They have done yeoman’s work and we all appreciate it. The

topic of discussion today is a new slant on an old problem. We only

have to go back one Congress in the old banking committee to recall the numerous hours spent debating the creation of insurance

capacity for disaster-prone areas. Individuals can disagree about

the nature of the solution.

The fact still remains that increasing capacity in our insurance

markets is incredibly important. Whether you are a disaster-prone

state like Florida or California, or from a state like mine, New

York, with terrorist-targeted properties, it remains to be seen how

much in the way of accumulated losses the private insurance and

reinsurance market can absorb before the entire market is put at

risk. As we see today, large insurers and reinsurers are being

downgraded by rating agencies and markets continue to harden.

When we last looked at the issue of natural disaster exposures,

2

there was mention made of using the capital markets perhaps as

a way to spread risk beyond the traditional insurance markets.

Let me quote from 1999 testimony in front of this committee.

′′The potential capacity from the capital markets should not be ignored or underestimated during consideration of what was then

Rick Lazio’s federal disaster reinsurance bill. While still in its infancy, a lot of resources are being directed by capital markets intermediaries to encourage the development of the market.′′ And further testimony stated, ′′The development of this risk-linked securities market would revolutionize catastrophe insurance funding and

greatly expand the capacity of the U.S. insurance market.′′

In other words, the private capital markets made sense then and

probably make even more sense now. Last year, Chairman Oxley

requested the General Accounting Office to look at the use of catastrophe bonds and their track record to date. Some in the private

sector suggested that what was once counted as the next big financing instrument never really took off in the market as anticipated. The committee asked the GAO to find out why exactly that

was. Specifically, the committee inquired, if it was a structural

problem, meaning these instruments are too complicated or

produce prohibitive transaction costs, or if it was because the market did not understand how to evaluate their underlying risk, or

if it was because the traditional insurance market was soft and

there was not a demonstrated need for new sources of capital.

GAO appears before us today to discuss its findings, with an emphasis on the barriers and hurdles these instruments face. The

team that put this report together is to be commended for their

work in taking such a complicated topic and really boiling it down

into its essential nuts and bolts. The committee greatly appreciates

the GAO’s work in this area and its cooperation with our committee staff in drawing its conclusions. Before I close, let me quickly make two points. The first is that this committee is looking to

facilitate capacity creation in the insurance marketplace. In this

case, we are examining catastrophe bonds. This is not to suggest

that a booming market for these bonds should replace or be an alternative to traditional insurance financing such as risk-spreading

by way of reinsurance.

Second, in no way should anyone leave this room thinking the Financial Services Committee is creating a new class of government

bond or government-backed security. This committee is simply

looking at ways to possibly remove barriers that will bring about

greater acceptance of an instrument that already exists in the marketplace today.

With that, the chair will recognize the gentleman from Florida,

my very good friend, Congressman Weldon. Congressman Weldon,

have you an opening statement?

[The prepared statement of Hon. Sue W. Kelly can be found on

page 30 in the appendix.]

Dr. WELDON. Yes, Madam Chairman. I apologize for being slightly late, Madam Chairman. I want to commend you for calling this

hearing on a very important issue, not just for my congressional

district in the State of Florida, but as well for the nation, and focusing the attention of the committee on the risks of catastrophic

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events. My state of Florida is wrestling with this very issue as it

braces itself for the kinds of storms that just hit Louisiana.

As is mentioned in the GAO study released today, the adequacy

of the insurance industry’s capacity to cover large catastrophes is

a difficult question to answer. As you know, I have introduced legislation that addresses this capacity question by establishing the

federal government as the insurer of last resort for mega-catastrophic events. The state of Florida experiences significant exposure to catastrophic events, yet people continue to relocate there,

making it one of the fastest growing states in the country. Florida

is also beset by litigation exposure, the complications of legislative

and regulatory efforts and other factors such as sinkholes and

mold.

Whether capital markets can enhance the capacity of an industry

affected by so many forces remains to be seen. Who must act to

stimulate the trading of risk-linked securities. Can they generate

the kind of resources necessary that would motivate both primary

insurers and reinsurers to confidently write more policies in Florida? Earlier this year, Chairwoman Kelly convened a hearing looking at the risks associated by not passing federal terrorism insurance legislation. During that hearing, Alice Schroeder, senior U.S.

non-life equity insurance analyst for Morgan Stanley, stated that,

quote, ′′Insurance companies generally destroy, rather than create,

value for their shareholders.′′ I look forward to hearing from today’s witnesses how risk-linked securities may overcome this dynamic, and I again thank you for calling this hearing.

I yield back.

Chairwoman KELLY. Thank you very much, Dr. Weldon.

Since there are no more opening statements, we will begin with

the witnesses on our first panel. Presenting the GAO report is Ms.

Davi D’Agostino, the director of financial markets and community

investment division from the General Accounting Office. Accompanying her is Mr. Bill Shear, also from the same division. Next

we will turn to the first of our two witnesses from the great state

of New York, and I would like to welcome Mr. Michael Moriarty

who is the director of the capital market bureau for the New York

Department of Insurance. Mr. Moriarty appears on behalf of the

National Association of Insurance Commissioners and serves as the

vice chair of the NAIC securitization committee.

We thank you for joining us today to share your expertise on

these issues. Without objection, your written statements will be

made part of the record. Ms. D’Agostino has agreed that GAO will

be given an extended period for its oral testimony, given the presentment of the report. All of our other witnesses will be recognized

for a five minute summary of their testimony, and if you have not

testified here before, at the end of the table there is a box that has

different colored lights in it. Red lights mean stop; yellow light

means you have one minute to sum up; and a green light obviously

means go.

With that, we turn to you, Ms. D’Agostino, and we greatly appreciate your presence here today.

4

STATEMENT OF DAVI D’AGOSTINO, DIRECTOR, FINANCIAL

MARKETS AND COMMUNITY INVESTMENT, GENERAL ACCOUNTING OFFICE

Ms. D’AGOSTINO. Thank you very much, Madam Chairwoman.

Madam Chairwoman and members of the subcommittee, I am

pleased to be here today before you to discuss our work on how

risk-linked securities are used to address catastrophic risks.

These risks arise from natural events such as hurricanes and

earthquakes. Population growth, real estate development and rising real estate values in hazard-prone areas increasingly expose

the nation to higher losses from natural disasters than in the past.

More than 68 million Americans live in hurricane-vulnerable coastal areas and 80 percent of Californians live near active earthquake

faults. A series of natural disasters in the 1990s, including Hurricane Andrew and the Northridge earthquake raised questions

about the financial capacity of the insurance industry to cover large

disasters—these are important words— without limiting coverage

or substantially raising premiums.

They also called attention to ways of raising additional sources

of capital to help cover catastrophic risk. The insurance industry

and capital markets developed risk-linked securities which both

supplement the insurance industry’s capacity and do provide an alternative to traditional property casualty reinsurance, which is insurance for insurers. Today, I will talk about one, how the insurance and capital markets provide coverage for catastrophic risk;

two, how risk-linked securities, specifically catastrophe bonds, are

structured and how they work; and three, how regulatory, accounting, tax and investor issues might affect the use of these securities

and the advantages and disadvantages of potential changes.

First, catastrophe risk is a global phenomenon, and insurance

and reinsurance companies with global operations often provide

coverage. The color map before you on the screen, as well as in our

report, highlights the areas of the United States that are most likely to experience certain types of natural catastrophes. Most insurance companies try to limit the amount and type of catastrophe

risk they hold on their books.

For example, if property casualty insurers have written too many

policies concentrated in California or Florida, they need ways to diversify and transfer that risk. One way is through reinsurance,

where for all or part of the premiums collected, the reinsurer

agrees to compensate all or part of an insurer’s claims as they are

incurred. When reinsurance prices or availability became problematic in the mid-1990s, insurers turned to risk-linked securities as

an alternative way to spread catastrophe risk. Now, I will turn to

the second area of my statement, which is how risk-linked securities are structured and how they actually work.

If you turn to page three of the written statement, you will see

a graphic that will help you walk through how they are set up, at

least in basic terms. Most risk-linked securities are catastrophe

bonds these days, and they have complicated structures, as you can

see, that are created off-shore. And they are created through special purpose entities which generally receive non-investment grade

ratings. To develop a catastrophe bond, a sponsor, which is usually

an insurance or reinsurance company, creates a special purpose reVerDate 11-MAY-2000 11:42 Feb 06, 2003 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 C:\DOCS\84418.TXT HBANK1 PsN: HBANK1
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insurance vehicle or an SPRV, which you will see in the graphic

before you, to provide reinsurance to the sponsor and to issue

bonds to the securities market. SPRVs, which are typically located

off-shore for tax and other advantages, receive payments in the

form of insurance premiums, interest, and investor principal; invest

in Treasury and other highly rated securities; and pay out to the

investors in the form of interest.

The reinsurance provided to the sponsor through catastrophe

bonds is different from that provided through traditional reinsurance contracts. Most of the recently issued catastrophe bonds are

non-indemnity based. This means that they are structured to make

payments to the sponsor upon the verified occurrence of specified

catastrophic events. The payments are also based on pre-agreed financial formulas. The payments from the investor’s principal to the

insurer/sponsor are not directly related to the insurer’s actual

claims, and they are triggered by an event that meets an objective

index or measure such as wind speed in the case of a hurricane.

In this way, the investors avoid exposure to the risk that the sponsor or primary insurer has poor underwriting or claims settlement

practices.

This very point is important to understanding some of the issues

that were identified by industry observers to us and the third area

of my testimony, the regulatory, accounting, tax and other investor

issues that challenge catastrophe bonds. Accounting treatment for

risk transfers occurring through non-indemnity-based catastrophe

bonds is a challenge for regulators. With traditional indemnitybased reinsurance, an insurer gets credit for reinsurance on its balance sheet in the form of a deduction from liability for the risk

transferred to the reinsurer, and can reduce the amount of regulatory risk-based capital required. Credit for reinsurance is designed to ensure that a true transfer of risk has occurred, and that

any recoveries from reinsurance are collectible.

Calculating the credit with indemnity-based coverage is fairly

straightforward. In contrast, it is very complicated to value the

true amount of risk transferred to determine credit for reinsurance

with nonindemnity-based coverage. The National Association of Insurance Commissioners is considering revising accounting treatment to accurately calculate and recognize nonindemnity-based reinsurance.

While these changes could facilitate the use of catastrophe bonds,

it is very important that the credit accurately reflect the true risk

transferred. Another development that could affect the use of catastrophe is a proposed change being considered by the Financial Accounting Standards Board to address consolidation of certain special purpose entities on a sponsor’s balance sheet. The proposed

guidance may increase the outside equity capital investment required and add other tests for a sponsor to treat an SPRV as ‘‘off

balance sheet’’.

While the proposed guidance is intended to improve financial

transparency in capital markets and to stem potential abuses of

special purpose entities, it could also increase the cost of issuing

catastrophe bonds. We also explored some of the tax issues raised

by industry representatives. These representatives are considering

a legislative proposal that would encourage domestic issuance of

6

catastrophe bonds by eliminating U.S. taxation of the SPRV. If special tax treatment were legislated, expanded use of catastrophe

bonds might occur.

On the other hand, under certain conditions, the federal government could experience tax revenue losses and other industry sectors might pressure the government for similar tax treatment. Also,

some elements of the insurance industry believe such legislation

would create an uneven playing field for domestic reinsurance companies.

Finally, unlike other bonds, catastrophe bonds, most of which are

non-investment grade, have not been sold to a wide range of investors. While investment fund managers we interviewed appreciated

the diversification aspects of catastrophe bonds, the risks are difficult to assess and investors are concerned about the bonds’ limited liquidity and track record. Madam Chairwoman, members of

the subcommittee, that concludes my oral summary and I would be

happy to answer questions.

[The prepared statement of Davi D’Agostino can be found on

page 56 in the appendix.]

Chairwoman KELLY. Thank you very much, Ms. D’Agostino.

Mr. Shear, do you have anything you want to add to that?

Mr. SHEAR. No, I do not think so.

Chairwoman KELLY. All right, thank you.

Mr. Moriarty? Before you start, let me just say that we have for

the audience facing this direction, you may not have seen the map

that the GAO had up on the back screen. I wonder if we could put

that map back up. I do not know how many people saw that. You

may be interested in taking a look at that. Can we leave it up

there for a little bit?

Good. Thank you.

I am sorry, Mr. Moriarty. Please go on.

STATEMENT OF MICHAEL MORIARTY, DIRECTOR, CAPITAL

MARKETS BUREAU, NEW YORK DEPARTMENT OF INSURANCE, ON BEHALF OF THE NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS

Mr. MORIARTY. Thank you, Madam Chairwoman. It is a pleasure

to be here today to provide the subcommittee with an update on

the state regulatory practices that deal with reinsurance and the

related use of securities to transfer insurance risk. You have my

written testimony, and I will try to use this allotted time to summarize the major points. State regulators are responsible for supervising activities of insurance companies that sell products here in

the United States.

One of our main tasks is monitoring the financial condition of

these insurance companies to ensure that they are able to honor

the obligations to their policyholders and to claimants. Insurers

that write policies here in the United States for the public invariably transfer some of the risk written to other entities in the insurance marketplace, primarily via the use of reinsurance. Like other

financial services, companies and insurers try to spread and diversify risk among many of the market participants.

Because a primary insurer is under obligation to honor these direct or original insurance contracts, it is critical to their financial

7

well being that reinsurers are able to reimburse a ceding company

for losses that are incurred. Hence it is incumbent upon regulators

to effectively supervise the reinsurer and any other form of risk

transfer. License reinsurers are subject to financial regulation similar to direct writing insurers.

Transactions with unlicensed reinsurers, especially those based

abroad, are subject to regulation that focuses on securing collateral.

A detailed explanation of the manner in which state regulators supervise reinsurance is included in my written testimony. Insurance

securitization is another means to transfer insurance risk. Instead

of transferring risk to the insurance marketplace, it is transferred

directly to capital markets investors.

The NAIC formed a working group on insurance securitization in

1998 to determine our regulatory response to developments in insurance securitization. The NAIC’s position is that U.S. regulators

should encourage the development of alternative sources of capacity such as insurance securitizations, provided adequate standards

governing these transactions are applied. Further deliberations of

the working group at the NAIC led to a determination that it will

be preferable if insurance securitizations could be done here in the

United States instead of off-shore.

To further that position, the NAIC has adopted separate model

acts to facilitate on-shore securitization using two different methods—protected cells and special purpose reinsurance vehicles.

Under the protected cell method, a segregated unit of the insurance

company would issue the debt securities. The funds taken in from

the sales of these bonds would be kept separate from the insurer’s

general fund. If there is a loss to the insurance company or a triggering event, money can be kept by the insurance company. If not,

it is paid back with interest to the bondholders.

The second method is the establishment of a special purpose reinsurance vehicle. This vehicle’s only purpose is to transfer insurance risk to the capital markets via investment securities.

As Ms. D’Agostino indicated, it is our understanding that an impediment to the utility of both of these options here in the United

States is tax uncertainty. Both of these methods depend on certain

tax treatment which may require amendments to the tax code. The

special purpose reinsurance vehicle needs a pass-through tax treatment. The protected cell needs to be recognized as part of the insurance company. The majority of the securitizations to date have

been done off-shore. Many states do not have the laws to enable

securitization vehicles and, as I indicated before, there are tax disadvantages or at least some uncertainty when doing these deals onshore.

From a regulatory perspective, doing these deals on-shore would

provide more transparency and better oversight. Even with traditional catastrophe reinsurance, coverage placed with non-U.S. reinsurers entails a certain amount of credit risk to the United States

ceding companies. U.S. laws require collateral, but only of incurred

losses. The sufficiency of collateral provided by off-shore reinsurers

can only be known for certain after a catastrophic loss has occurred. Credit and collateral risk are clearly reduced by the use of

securitization since they are required under the model laws to be

fully funded.

8

Due to that security, companies that transfer risk via

securitization now get credit on the balance sheet and income

statement for the transfer of risk. Insurers’ underwriting accounts,

which measure the profit and loss for insurance transactions are

adjusted accordingly for these indemnity-based transactions. The

use of index-based triggers on non-indemnity transactions is more

challenging. It is important that the basis risk in these types of

transactions be measured or managed by the ceding company, and

the NAIC is working with the industry on developing means to

both measure and manage this basis risk. In conclusion, the NAIC

supports creating an environment that facilitates a more fluid

transfer of insurance risk to the capital markets.

Given the amount of capital in the property and casualty industry, a major catastrophe or series of catastrophes could strain the

ability of the industry to respond to its customers. Capital markets

have the capacity and apparent willingness to take on insurance

risk. Capital markets also have precedence in the securitization of

other risks such as mortgages, credit card receivables and other

types of cash flows. The securitization of insurance risk is not a

cure-all for the funding of catastrophe risk. We see it as an addition, rather than a replacement to traditional reinsurance. We cannot gauge the appetite of capital markets investors for these securities.

However, the NAIC believes it is important to enable the marketplace to make that determination. Other initiatives to address capacity needs for catastrophe and for other types of coverage should

continue to be explored.

This concludes my oral summary and I would be happy to address any questions the subcommittee may have.

Thank you.

[The prepared statement of Michael Moriarty can be found on

page 72 in the appendix.]

Chairwoman KELLY. Thank you, Mr. Moriarty. Ms. D’Agostino,

in your report you break down the analysis of cat bonds into four

main areas—regulatory accounting treatment, capitalization requirements, taxation and assessing the investment risk. Based on

your analysis, can you rank the relative order of importance of

these areas and offer recommendations to address them?

Ms. D’AGOSTINO. I think that it would be very difficult to rank

them in order of importance. Some of them hinge upon each other

and some of them are totally unrelated to each other. The accounting and tax treatment are mainly issues pertaining to whether

these SPRVs come on-shore or not, and also in terms of the Financial Accounting Standards Board proposal, there are arguments

that say that if the 10 percent outside equity capital requirement

applied to these vehicles, then they would probably go away.

We are not sure about that, but we know that they would become

a lot more expensive to issue and create. One of the key areas I

think that really has an impact, and I think some of the people

who will talk later will talk to this even more, is the investor-related issues. These are relatively new securities instruments so

they do not have a great track record, and people are looking for

a track record. There are some attractive elements to the bonds, esVerDate 11-MAY-2000 11:42 Feb 06, 2003 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 C:\DOCS\84418.TXT HBANK1 PsN: HBANK1
9

pecially the fact that they do not correlate with other risks in a

portfolio.

At the same time, very few are issued, there is limited liquidity

in them, and it is very difficult for people to evaluate the risk or

get a comfort level with the risks in the catastrophe bonds. Further, some people who have not bought these—because we did try

to find out from people who have not bought catastrophe bonds

why they have not bought—and there were some concerns raised

about their suitability for a certain element of investors in, say, a

mutual fund—the more moderate income investors. I think that is

a pretty important challenge to overcome.

Even if you took care of some of the other issues, you still would

have that hurdle to deal with—trying to educate investors and

make them more comfortable with purchasing catastrophe bonds

and finding a place in their portfolio for them.

Chairwoman KELLY. Ms. D’Agostino, have you any recommendations for creating or helping people have some sense that these instruments are worthy of investment?

Ms. D’AGOSTINO. No, I do not. These instruments are very highrisk and high-return-type instruments, and they are noninvestment-grade bonds, not that that is a deterrent in and of itself, but

GAO is not in the business of recommending bonds and the like.

We do not have any recommendations for this, otherwise our report

would have included them. I think our whole point of doing the

work for you was to present the information to you and allow the

policymakers to decide on where to go with this. We feel that we

have gone as far as we can go in this area.

Chairwoman KELLY. Thank you. I thought it was worth a try.

[Laughter.]

Mr. Moriarty, I believe that the NAIC and possibly you have

seen a draft of this report, and I wanted to know if you would care

to comment, either for yourself or for the NAIC?

Mr. MORIARTY. We have not reviewed it at the NAIC level, so I

will just give you my preliminary comments, Madam Chairwoman.

I think the GAO did a very good job in setting out the issues, certainly from a regulatory perspective. With respect to the appetite

of the marketplace, the investor concerns and even the tax issues

there are outside of the purview of insurance regulators. I do not

mean to operate in a vacuum here, but just looking at the financial

solvency of the ceding companies, we think the biggest issue is with

the non-indemnity-based transactions, which I think the capital

marketplace would buy more of, so to speak, than the indemnitybased. I do think, though, that the basis risk can be addressed.

There are not best practices in terms of the insurance industry

in measuring basis risk, partly because there have not been these

transactions out there before and they have not had to measure it.

But nonetheless, there is a great deal of talent in the industry in

measuring and managing this risk, and we do think that disclosure

of how companies measure basis risk when using these instruments can provide the regulators with a good basis to determine

whether there has been in fact transfer of risk.

But again, going back to the report, we think it does state all of

the issues that have been out there over the past four or five years

in an accurate manner.

10

Chairwoman KELLY. Thank you very much. I am out of time.

Dr. Weldon, any questions?

Dr. WELDON. Yes, thank you very much, Madam Chairman.

Ms. D’Agostino, maybe you cannot answer this, but I will ask it

anyway, how much capacity for coverage of natural disasters is

likely to be added through risk-linked securities in the near future?

Ms. D’AGOSTINO. We did not undertake to try to project the future market for risk-linked securities. They have been covering a

growing segment of reinsurance and catastrophe reinsurance, but

I do not think that we are in a position to—

Dr. WELDON. I think your report, correct me if I am wrong, indicates it is one-half of one percent?

Ms. D’AGOSTINO. That is according to a Swiss Re report.

Dr. WELDON. So you say it is growing—it went from zero to onehalf of one percent?

Ms. D’AGOSTINO. Well, it is growing in real dollar terms as well,

into the billions of dollars.

Dr. WELDON. Is that right?

Ms. D’AGOSTINO. Yes. And actually catastrophe bonds have been

written to cover Florida hurricanes as well as California earthquake perils.

Dr. WELDON. Okay. Would you agree it is kind of hard to speculate at this time the potential performance in the future, even

though the real dollar amounts may be growing? As a percentage

of risk, it is still quite negligible?

Ms. D’AGOSTINO. It is very difficult to project, for us anyway.

Dr. WELDON. You did not look at all at the rate of growth? Is it

linear? And is it affected by economic variables at all?

Ms. D’AGOSTINO. Bill, do you want to take that?

Dr. WELDON. I know we did not ask you to study all these things,

so I am not—I am just trying to get answers to some of these questions.

Mr. SHEAR. The growth has been relatively unlevel, and you

would expect that because one of the major determinants is the

price and availability of reinsurance through traditional reinsurers.

So it has largely been dependent on certain events that affect the

pricing of traditional reinsurance.

Dr. WELDON. Mr. Moriarty, in your estimation are we currently

facing a capacity crisis? You say yes, is that right?

Mr. MORIARTY. Well, I think in terms of looking at the availability and the affordability of reinsurance, it has clearly spiked in

the last year or year and a half. Throughout the 1990s,

resinsurance was by all measurements very available and very affordable.

Certain events—certainly when you talk about the events of 9-

11 with respect to terrorism coverage, and the availability of capital in the insurance industry, it is a hard market. So it has become

more difficult to get insurance, and one would think that this

would be the marketplace where alternatives such as insurance

securitization would see a spike in activity. Whether it is an availability and affordability crisis, at this point I do not think so, but

again clearly it is becoming more difficult to get reinsurance on

terms that are favorable to ceding companies.

11

Dr. WELDON. Do either of you from GAO, Mr. Shear and Ms.

D’Agostino want to add to that at all? Do you disagree or agree?

Mr. SHEAR. I do not disagree that recently it appears from the

information we analyze that there have been increases in prices in

certain types of reinsurance, and reduced availability. Part of the

question which again we do not want to forecast, is how large the

response would be to catastrophe bonds and potentially other forms

of risk-linked securities.

Dr. WELDON. Mr. Moriarty, would you characterize the crisis as

national or regional? Is it based on the nature of the risk?

Mr. MORIARTY. I would characterize the increasing prices and the

increasing lack of coverage to be national. Anecdotally, I have

heard that it is becoming more difficult in certain catastropheprone areas to secure reinsurance, but that is more anecdotal. But

clearly, across the board the prices of reinsurance and the terms

that ceding companies have been able to secure are becoming more

difficult across the board.

Dr. WELDON. And you do not see a specific impact of a certain

kind of peril on that availability at all? It is across the board, nationwide, and not affected by the peril being insured for?

Mr. MORIARTY. On a very broad basis, I think commercial reinsurance is more difficult to secure, and clearly terrorism coverage

stands by itself on the side as being very unavailable and very

unaffordable.

Dr. WELDON. Thank you, Madam Chairman.

Chairwoman KELLY. Thank you, Dr. Weldon. I would like to go

back to you, Ms. D’Agostino. The GAO’s report states that SPRVs

are typically located off-shore for tax, regulatory and legal advantages. Wouldn’t consumers be better advantaged if we improved

our tax and regulatory treatment and bring the SPRVs back into

the country, both for capital investment and for regulatory control?

Ms. D’AGOSTINO. I think arguments can and have been made on

both sides. With every action one could take to improve the conditions for domestic SPRVs and catastrophe bonds on-shore, there

could be a co-related trade-off. I mean, everything involves tradeoffs. It is really up to the Congress to weigh those trade-offs and

decide for itself as a matter of policy and law which direction it

wants to take.

Chairwoman KELLY. That is a very interesting answer.

Thank you.

Mr. Moriarty, how soon can we expect the NAIC to revise its accounting treatment for risk transfer to help facilitate securitization

of disaster risk?

And once the NAIC adopts the changes, who has to promulgate

the changes in order to have them be effective?

Mr. MORIARTY. I will separate that into two responses. With respect to the indemnity-based transactions which reimburse the

ceding company on a dollar-for-dollar basis, the NAIC has already

promulgated accounting standards to allow, or have accounting

standards in place with respect to special purpose vehicles, to allow

companies to take credit for this transfer of risk. With respect to

the model laws that allow the formation of protected cells, I believe

that seven states thus far have enacted that model. With respect

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to special purpose reinsurance vehicles, two states have adopted

the model.

The other part of the answer with respect to the non-indemnitybased triggers, my sense is that the NAIC would be in a position

next year to promulgate accounting guidance with respect to indexbased securitization transactions. Being an accounting standard, it

need not be adopted on a state-by-state basis. Most state statutes

adopt the NAIC codification of statutory accounting principles once

they are adopted by the NAIC, although states have the option of

not adopting NAIC-specific principles. So I think we are looking at

next year to finalize the accounting rules with respect to nonindemnity-based transactions.

Chairwoman KELLY. Thank you. Mr. Moriarty. What concerns do

you have with the use of off-shore SPRVs? Do you share a similar

concern with traditional reinsurance provided by off-shore entities?

Mr. MORIARTY. Well, the securitization deals that have been done

off-shore have been done by a select number of either companies

or investment banks who have been more than willing to share information with us. Nonetheless, the fact that they are done offshore could lead to a concern for transparency when looking at a

transaction.

We think that there would be a lot of benefit in terms of sheer

transparency if they were done on-shore, if they were subject to review by state regulators. Clearly, that would enhance our ability to

get all the details should there be a concern sometime in the future. But that being said, the deals that have been done off-shore,

they are not inherently bad. Just from a pure transparency viewpoint, regulators would be better served if they were done on-shore.

Chairwoman KELLY. Thank you. I would like to ask you both,

based on your discussions with private sector people, what segment

of the market is most likely to use these risk-linked securities? Can

you give me a reason why? I have a follow-up question to that, but

I would like to hear your answer to this. Can you give me—either

one of you—just please answer that one question. Ms. D’Agostino,

do you want to start?

Ms. D’AGOSTINO. If you are talking about the investment side, it

is institutional investors. Part of that is driven by the nature of the

catastrophe bonds, and part of it is driven by how they are issued

under a specific type of rule, 144b, that the SEC is in charge of.

If you are talking about from the issuance side, mostly insurance

companies and reinsurance companies issue them. The other interesting fact is that insurance companies and reinsurance companies

also buy them. So it is just—it is an interesting area.

We have learned a lot, and some of the things I cannot explain,

like why a part of the industry that both buys them and issues

them might feel uncomfortable with risk-linked securities coexisting in the marketplace with regular reinsurance.

Chairwoman KELLY. Would transparency help? Would increased

transparency help, as Mr. Moriarty pointed out?

Ms. D’AGOSTINO. I am really not sure. I think the transparency

might make certain investors more comfortable with them.

Chairwoman KELLY. Mr. Moriarty, would you like to answer that

question? MORIARTY: Sure, Madam Chairwoman. From the insurance industry point of view, most of the deals done to date have

13

been securitization of the very high level catastrophe risk, and we

would see that trend continue in view of the apparently increasing

price for reinsurance coverage as the return to investors in a

securitization deal would better match the risk that they are undertaking. Again, I have heard from the investor’s viewpoint, I

think establishing those is correct.

These have been big institutional investors and you will hear

from one of them this afternoon—and there apparently is some

attractiveness to these types of securities in terms of their non-correlation to the rest of their investment portfolio, as the happening

of a catastrophe has nothing to do with the sliding real estate market or concerns in the equity of the bond market. But again, the

utility of these bonds and these deals to date have been to provide

the upper layers of catastrophe covers, and I would think that they

would continue along those lines. Conceptually, I think it could

cover any high level type of risk.

Chairwoman KELLY. Thank you. Dr. Weldon, have you another

question?

Dr. WELDON. I just have one or two more questions, Madam

Chairman. For the GAO witnesses, could you expand on the fact

that risk-linked securities are considered non-investment-grade,

and do they help diversify a portfolio? Could these securities be

considered a hedge to help investors reduce market risk? Is that

the proper way to describe them? Do they therefore then become

not an investment of first choice?

Ms. D’AGOSTINO. Where do we begin?

Mr. SHEAR. Yes, where do we begin?

Ms. D’AGOSTINO. Maybe the—

Dr. WELDON. Mr. Moriarty, you are free to comment on that.

Mr. SHEAR. The noninvestment-grade bonds—as we know, there

are fairly large transparent markets for noninvestment-grade

bonds generally. These are different types of noninvestment-grade

bonds. They have the advantage of not being correlated with other

forms of credit risk. In terms of some of the questions with transparency, by definition a bond market is going to have greater

transparency than the traditional insurance market, which is governed by private contracts.

To some degree in terms of talking about where this could go and

why we are so uncomfortable projecting where these would go, the

extent to which any changes along tax or regulatory fronts, other

types of fronts, could facilitate use of risk-linked securities, there

are advantages to the greater transparency that could occur. There

could be more discovery in the marketplace. But this could be a circular argument in the sense that we say there is limited liquidity

which limits their attractiveness, yet that limited liquidity in a

sense is searching for a larger market.

So that becomes the big question. We are not quite sure what the

response would be to any legislative or other changes. But by the

same token, the hope of the market—I think you will hear more

on that from the second panel—would be if liquidity could be increased, you might have greater transparency and perhaps a larger

investment base.

Dr. WELDON. Did you want to add to that at all, Mr. Moriarty,

or would you rather steer away from the issue?

14

Mr. MORIARTY. Again, they are generally noninvestment-grade

securities, but there are many noninvestment-grade securities out

in the marketplace. Rating agencies review these securities and

they assign a rating based upon the probability of default. These

bonds have a probability of default, i.e. of a catastrophe happening,

the same as any other noninvestment-grade bond. When we look at

insurance company portfolios, we look at their credit quality; we

look at diversification.

To the extent that a life insurance company would hold a catastrophe bond would not alarm us any more than they would hold

any other noninvestment-grade bond. Clearly, if they made up a

large part of their portfolio or if they did not have the capital to

support it, it would cause a concern. But again, I do not think

these stand out there as a class by themselves in comparison to all

the other noninvestment-grade-type securities.

Dr. WELDON. Thank you very much, Madam Chairman.

Chairwoman KELLY. Thank you, Dr. Weldon. If there are no further questions, the chair notes that some members may have additional questions that they may wish to submit in writing. Without

objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place

their responses in the record. The first panel is excused, with this

committee’s great appreciation for your time.

If the second panel will take their seats at the witness table, I

will begin the introductions. On our second panel, we will begin

with Mr. Christopher M. McGhee, who is the managing director of

the Marsh and McLennan Securities Corporation, testifying on behalf of the Bond Market Association. Next, we will hear from Mr.

John Brynjolfsson, who is the executive vice president of PIMCO,

the Pacific Investment Management Company, one of the world’s

largest fixed-income managers with over $270 billion in fixed income investments.

Finally, we will hear from Mr. Dan Ozizmir, who is the senior

managing director of trading for the Swiss Re Financial Products

Corporation, whose American headquarters is located in Armonk,

New York. I want to thank you all for taking time out of your busy

schedule, and I really appreciate the fact that you are with us

today. So without objection, your written statements will be made

part of the record.

You will each be recognized in turn for a five-minute summary

of your testimony. If you are ready, Mr. McGhee, we would like to

begin with you.

STATEMENT OF CHRISTOPHER M. MCGHEE, MANAGING DIRECTOR, MARSH & MCLENNAN SECURITIES CORPORATION,

ON BEHALF OF THE BOND MARKET ASSOCIATION

Mr. MCGHEE. Good afternoon. On behalf of the Bond Market Association, I would like to thank the committee for holding this

hearing on risk-linked securities. My name is Christopher McGhee

and I am a Managing Director of Marsh and McLennan Securities

Corporation in New York. I also serve as chairman of the RiskLinked Securities Committee of the Bond Market Association. This

committee includes representatives of securities firms that are acVerDate 11-MAY-2000 11:42 Feb 06, 2003 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 C:\DOCS\84418.TXT HBANK1 PsN: HBANK1
15

tive in the primary distribution and secondary trading of risklinked securities.

I should note that my firm is an affiliate of Marsh and

McLennan Companies, a global professional services firm whose

operating companies include the world’s leading insurance and reinsurance brokers.

I have submitted a statement for the record that includes a diagram of standard catastrophe bonds transactions. I will summarize

my written statement here and will be happy to answer any questions the committee may have at the end of testimony.

Risk-linked securities developed in the wake of the major catastrophes of the 1990s. Following Hurricane Andrew in 1992 and the

Northridge quake in 1994, catastrophe reinsurance prices more

than doubled and became much more difficult to obtain. Risk

securitization had been discussed in years preceding the natural

disasters of the 1990s, but it really took the capacity crunch and

price spike caused by Andrew and Northridge for securitization to

be seen as a realistic risk-transfer mechanism. Risk securitization

has the potential to generate significant sources of catastrophe

risk-taking capacity on the part of insurers and reinsurers.

This would, in turn and most importantly, enable insurers to assume greater amounts of catastrophe risk from their policyholders.

Much as the secondary mortgage market brought the cost of home

finance down significantly, we hope that insurance securitization

could make catastrophe protection more broadly and more cheaply

available to policyholders.

We hope that such an increase in coverage would substantially

reduce the burden on the federal government to provide emergency

disaster relief to uninsured homeowners following a natural catastrophe. Bear in mind, at the end of 2001 only 17 percent of Californians had earthquake insurance.

Since 1997, 45 catastrophe bond transactions have been completed, with a total risk limit securitized of almost $6 billion. While

this figure is not insubstantial, it could be larger.

We do believe there are certain actions which could be taken

which would facilitate the development of this marketplace. These

include, first, permitting reinsurance special purpose entities to be

treated as flow-through vehicles from a tax perspective. As in all

securitizations, repackaging risk requires the use of a special purpose entity. Establishing the SPE in the jurisdiction of the U.S. tax

code would subject the RLS transaction to two layers of U.S. federal tax and perhaps even state taxes, making the transaction

more costly for issuers and less attractive to investors. As a result,

the bulk of all these transactions today take place off-shore in jurisdictions with no entity-level tax.

To fix this problem, Congress could permit reinsurance SPEs to

be treated as flow-through vehicles that would not be taxable at

the entity level. This has already been done with mortgage-backed

securities under REMICs and FCTs This would encourage risk

securitization to come on-shore and as such would be less costly

and less complicated to transact. We believe that this would result

in an increase in transactions overall, and as noted, policyholders

would be the ultimate beneficiary of this new risk capacity.

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This issue is, of course, a matter involving the tax code and as

such we recognize that this is not subject to the jurisdiction of this

committee, but rather than of the Committee on Ways and Means.

Therefore, we mention this here only so that we can be complete

on the issues facing the marketplace.

The second action would be to ensure that the economic substance of all these transactions are taken into account under the

pending accounting rules concerning the consolidation of SPEs. In

short and in general, we do not believe that any entity other than

the SPRV should be made to consolidate the risk-linked security

onto its balance sheet, specifically neither the sponsor of the transaction or any investor should be required to consolidate the full

transaction.

Accounting consolidation we think would produce misleading financial statements because the consolidation does not reflect the

economic exposure of the parties to the transaction.

Let me conclude with these final points on behalf of the association. First, risk-linked securities are beneficial to policyholders as

they can help expand the availability of competitively priced catastrophe insurance. Second, the RLS market can relieve pressure on

governments to insure catastrophe risk.

Third, flow-through tax treatment of RLS would bring transactions on-shore and we believe would encourage the further development of this marketplace. Again, we recognize that any action on

this matter is within the purview of the Committee on Ways and

Means.

Fourth and finally, the proposed FASB accounting rule as currently contemplated should not require consolidation of the SPE’s

balance sheet in the financial statement of any party involved in

the transaction.

A contrary result would be severely detrimental to the development of the RLS marketplace. Thank you for providing the Bond

Market Association the opportunity to testify.

[The prepared statement of Christopher M. McGhee can be found

on page 64 in the appendix.]

Chairwoman KELLY. Thank you very much, Mr. McGhee.

Mr. Brynjolfsson?

STATEMENT OF JOHN BRYNJOLFSSON, EXECUTIVE VICE

PRESIDENT, PIMCO

Mr. BRYNJOLFSSON. Madam Chair and members of the Committee on Financial Services, I welcome this opportunity to share

my expertise and recommendations. This testimony is offered in my

capacity as an individual with extensive experience relating to risklinked securities, and not in my official capacity as an officer of

PIMCO.

I believe that the risk-linked securities market holds great promise for your constituents and our nation more generally. I therefore

am strongly supportive of your efforts to foster the unfettered development of this market. The committee has forwarded to me six

questions, four of which I will answer now orally. Question one,

what attracts investors to risk-linked securities?

Risk-linked securities can provide investors with a handsome

yield in exchange for absorbing a small amount of risk. I will give

17

an example. Five years ago in 1997 and every year since, PIMCO,

my employer, has participated in a transaction known as residential reinsurance. This risk-linked security allowed USAA, one of the

nation’s largest insurers of military personnel, to cede $400 million

of super-catastrophic risk to the capital markets. PIMCO purchased 17 percent of that transaction, representing $69 million of

catastrophic hurricane risk.

In particular, the risk-linked security PIMCO bought was only

exposed to the most catastrophic of hurricanes—for example, a category five hurricane passing directly over Miami, where a large

number of retired and active military personnel reside, would have

triggered a loss on this bond. In contrast, a category four hurricane

passing 20 miles south of Miami, as Hurricane Andrew did in 1993,

would not have triggered a loss. Despite a relatively handsome

yield, the risk of loss on these bonds could be quantified as a once

in 100-year event.

Question two, what factors have limited your investment in risklinked securities? One factor that has limited our use of risk-linked

securities is that our competitors rarely use them. As a result,

upon the first serious loss, our use of risk-linked securities may become a lightning rod for journalists and lawyers who would be

quick to second-guess our decision.

Question three, should individuals invest in risk-linked securities? The risk-linked securities market is by no means appropriate

for the direct participation of individual investors. Generally, all

risk-linked securities issued in the U.S. have been issued under the

framework of regulation 144(a) that limits participation to qualified

professional asset managers. Individuals can and do, however, appropriately access the risk-linked securities market in a very small

dose through broadly diversified mutual funds managed by competent professionals.

Question four, what does the future hold? I would suggest that

the risk-linked securities market is currently struggling to get any

notice whatsoever. This is temporary and simply caused by the

substantial turmoil that the equity and corporate bond market are

currently experiencing. Ultimately, the risk-linked securities market will likely develop into an instrumental part of the global reinsurance infrastructure.

Before I conclude, allow me to more concretely and specifically

highlight for you how I think the development of the risk-linked securities market will impact your constituents.

First, the risk-linked securities market has the potential to substantially and dramatically increase the capacity and lower the cost

of capacity in the reinsurance market. This is particularly true in

the case of capacity relating to super-catastrophic risks—those once

in a hundred-year events that inevitably occur and fill the pages

of Life magazine.

Increasing this capacity frees up the limited capacity reinsurance

companies have to address more complex risks such as terrorism.

Ultimately of course, expanding capacity benefits both individual

and small business consumers of insurance services. Your constituents may benefit a second time when the premiums the insurance

industry charges are passed through in the form of interest on

18

bonds to your constituents’ pension plans, mutual funds and other

investment vehicles.

One last constituent is the IRS, whose revenues have the potential to benefit from the development of a robust risk-linked securities market. As the risk-linked securities market develops, premiums traditionally earned by distantly domiciled insurance companies will begin to be earned instead by taxpayers. I commend

this committee for its proven success in making the U.S. financial

markets more competitive globally.

Specifically with respect to risk-linked securities, I am supportive

of your efforts to firstly lower barriers to development of the risklinked securities market; two, to encourage the understanding and

foster prudent use; three, to enhance market efficiency by promoting increased transparency and risk disclosure; four, solidify

the contractual nature of risk-linked securities; five, streamline

regulation and enable on-shore domiciling of special purpose reinsurance vehicles; six, standardize the fragmented nature of state

insurance regulations. Most distinguished members of this committee, thank you for your interest. I am of course available to answer your questions.

[The prepared statement of John Brynjolfsson can be found on

page 33 in the appendix.]

Chairwoman KELLY. Thank you very much, Mr. Brynjolfsson.

Mr. Ozizmir?

STATEMENT OF DAN OZIZMIR, SR. MANAGING DIRECTOR OF

TRADING, SWISS RE FINANCIAL PRODUCTS CORPORATION

Mr. OZIZMIR. I would like to thank Chairwoman Kelly and Chairman Oxley for holding this hearing on risk-linked securities, an important and growing segment of the fixed-income and reinsurance

markets. My name is Dan Ozizmir. I am the senior managing director and head of trading with Swiss Re Financial Products, a

subsidiary of Swiss Re, the largest reinsurer in North America and

second largest in the world. Swiss Re is also a member of the Reinsurance Association of America and the Bond Market Association.

Swiss Re has an interest in this market from two primary perspectives.

We structure and underwrite new risk-linked securities and we

access the risk-linked securities market as an alternative source of

capital. Insurer motivation—to make sure it can pay claims after

a catastrophe, an insurer can do the following: raise more equity

capital by selling company stock; transfer risks to the reinsurance

markets; limit risks by underwriting and asset management process. While not a perfect substitute for any of these approaches,

transferring risks to the risk-linked securities market is a useful,

fixed-cost, multi-accompaniment to these other tools for certain

peak catastrophic risks to the insurance industry, such as east

coast hurricanes and California earthquakes.

As an aside, an insurer needs to hold significantly more equity

to underwrite peak exposures, like a Florida hurricane and California earthquake, than it does to underwrite non-peak exposures

such as a single house fire or an auto accident. In fact, equity is

an extremely efficient source of capital for non-peak exposures, as

19

we can use the same dollar of capital to underwrite many dollars

of coverage.

The lower the cost of capital to insurers, the greater the availability of affordable insurance to policyholders. Making affordable

insurance more available has important public policy implications.

For example, as of the end of 2001, only 17 percent of California

homeowners had earthquake insurance.

Presumably if earthquake coverage were less expensive, more

consumers would obtain coverage. This in turn would reduce the

potential burden on the government to provide emergency disaster

relief following a major catastrophe. Investor motivation—generally, bond investors buy risk-linked securities, often known to

them as cat bonds, to diversify their investment portfolios.

Adding risk-linked securities to a fixed-income portfolio reduces

the expected standard deviation for the portfolio. In other words,

the returns stay similar, but the portfolio risk goes down. This occurs because defaults on corporate bonds and natural disasters are

not correlated. Given these diversification benefits, an obvious

question is, why have many significant fund investors stayed on

the sidelines. I have a more complete response in my written testimony, but the short answer is that some professional investors

take the time to learn about the sector and get comfortable, while

others have not yet done so. Mr. Brynjolfsson from PIMCO today

is an exception.

The risk-linked securities market current status and future directions—at present for our company, risk-linked securities represent a relatively small, but strategically important source of capital. At present, we believe that while some low-rate insurers and

reinsurers might face capital strain from the equivalent of two natural catastrophes on the order of Hurricane Andrew, yet industry

as a whole remains capable of meeting its obligations. Note that

notwithstanding the estimated insured losses from September 11,

which were greater than Hurricane Andrew and the Northridge

earthquake combined, reinsurance remains readily available.

A major exception, of course, to this rule is terrorism coverage,

which is either not available or extremely expensive. On the whole,

we expect the risk-linked securities market to continue to grow in

several ways. First, we would anticipate the absolute amount of securities outstanding to continue to grow as new investors begin to

participate and existing investors devote more capital to the sector.

Second, we anticipate that over time, innovation will gradually

broaden the types of risk securitized. On the second point, I would

note in particular that the risk-linked securities market is not a

near-term solution for providing capacity for terrorism risk. Terrorism risk cannot be quantified.

We believe that the only solution to this important and difficult

problem is passage of a government backstop. In conclusion, we believe that the risk-linked security market plays a useful role in providing additional capital to the reinsurance and insurance industry.

To the extent that it succeeds, it can also help increase the availability of affordable insurance to policyholders exposed to peak perils and therefore reduce the amount of uninsured losses from natural catastrophes. This concludes my testimony. Thank you very

much.

20

[The prepared statement of Dan Ozizmir can be found on page

215 in the appendix.]

Chairwoman KELLY. Thank you very much, Mr. Ozizmir.

I have a question for you, Mr. McGhee.

If the FASB adopts new rules governing SPRVs to increase their

equity requirements, how would that affect your securitization efforts to help protect consumers against natural disasters?

Mr. MCGHEE. We think it would clearly inhibit the growth of

that sector. It would add expense, certainly. The equity component

of a transaction would need to be paid more than they currently

are under the fixed-income approach, so there would be an expense

component there.

But in addition, there is a challenge in finding equity investors

for these kinds of transactions. This is traditionally been a fixedincome market for fixed-income investors. Finding equity investors

for this transaction we think is complicated and difficult. So we actually believe it would be a significant impediment to the growth

of this marketplace.

Chairwoman KELLY. Thank you. Mr. Brynjolfsson, how can we

facilitate the acceptance of natural disaster bonds by the investment marketplace? Do you think we need to help standardize information parameters or to improve the disclosure requirements? I

asked this question of the prior panel. I would be interested in

what you have to say.

Mr. BRYNJOLFSSON. Sure. At our firm, we have done everything

that we can do to, let’s say, maximize disclosure; and to actually

limit these securities strictly to portfolios where the clients have

previously acknowledged that we have the authority to invest in

these bonds. Even there, we are still somewhat concerned about liability associated with our investing in these types of bonds.

It may just be a matter of education. What the committee is

doing today in the form of publicizing, in effect, the GAO report

and having hearings on this topic may help move the market in the

direction of acceptance. Investors quite appropriately are concerned

about the risk in their portfolios, now more so than ever. We have

invested time and effort in developing the expertise to invest in

these bonds.

To some extent, I have tried to facilitate our competitors’ developing expertise by speaking at the Bond Market Association conferences on these topics and so on. But ultimately, my job is to take

care of my investors and I hope others do the same for their investors.

Chairwoman KELLY. How would you assess the current market

for these risk instruments?

Mr. BRYNJOLFSSON. Well, we have been an aggressive purchaser

of these bonds, sometimes buying 25 percent or even 30 or 40 percent of individual transactions that have come to market over the

past five years. In the past 12 months or so, we have been a little

bit less aggressive. Part of the reason for that is the appetite for

risk among the capital markets has been waning.

We have to some extent anticipated that, to some extent just

been a victim of it. But the whole purpose of integrating the reinsurance market with the capital markets is to bring the reinsurance markets away from the reinsurance cycle that you may be

21

aware of where reinsurance rates harden and soften and harden

and soften. Unfortunately, capital markets also have a cycle where

capital market investors get driven by fear and greed and then fear

and then greed. Right now, fear is the dominant sentiment in capital markets.

Chairwoman KELLY. I have another question for you, and that is,

do you really need a Ph.D. in physical sciences in order to understand this risk?

Mr. BRYNJOLFSSON. You know, I have spent the past 12 years intensely focusing on the financial markets. Obviously, these securities are by and large a financial security. The firms that model the

risk of this will have a dozen or more than that—50 or 60—Ph.D.

scientists all evaluating the latest theories in earthquake, hurricane and so forth. Having some credentials in the physical sciences

at least gives me some confidence that I can, let’s say, read the reports that these scientists publish. I do not know if I would want

to write them.

Chairwoman KELLY. Our hat is off to the GAO, I guess. I have

run out of time here, so I am going to turn to

Dr. Weldon. Dr. Weldon, have you questions?

Dr. WELDON. Yes, thank you, Madam Chairman. I have got a

question for Mr. McGhee and maybe Mr. Brynjolfsson, you can

comment on it, too. There was some discussion—Mr. Brynjolfsson,

you purchased a bond for a category five hurricane going over

Miami.

Mr. BRYNJOLFSSON. Correct.

Dr. WELDON. Let me start with you, Mr. McGhee. What do you

think would be the impact on the market if that were to happen?

Mr. MCGHEE. If there were an event like that?

Dr. WELDON. Next week.

Mr. MCGHEE. We have talked a lot about that question. The concern has always been that a big loss occurs and as a result investors exit the market. Our sense is that the investor universe in this

particular category is extremely well informed. They understand

the risks they are running, and we believe that it is unlikely that

they would immediately exit the marketplace.

We think in fact that this might draw more investors in because

the opportunities to buy more bonds at increased prices or increased yields we think would be available. So our sense is that investors would not cut and run; that they would actually stay there.

We think this marketplace does have staying power.

Dr. WELDON. Do you agree with that, Mr. Brynjolfsson?

Mr. BRYNJOLFSSON. Well, there are two parts to that question.

One is will the capacity we provide be there when an event occurs.

As a major hurricane occurs, market participants start to get white

knuckles and start to brace. Trading activity, pricing of the risk

may occur. Bond prices may fall.

However, our firm is not really well positioned to monitor the

minute-to-minute development of hurricanes. As a result, we are

essentially buying these bonds ahead of time with the belief and

plans to hold them throughout any disaster. Then we will see how

the sword falls, and I hope avoid dying by the sword, if you will.

So what that means is that the capacity that is provided is there

and will be there for the event that occurs. The second part of the

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question implicitly is, on subsequent events, would we necessarily

step up and provide additional capacity.

As Mr. McGhee suggested, probably not unless the price were

even more attractive than initially. There is actually a market for

what we call second event bonds, and we do participate in the second event bond market. That is a market where we are actually

paid a premium in order to absorb the possibility of two major catastrophic events occurring.

The second event market is really a good example of how the

capital markets can step in to provide not just backup capacity, but

backup capacity to the backup capacity.

Dr. WELDON. I was not aware of this. This is a developing market, you are saying?

Mr. BRYNJOLFSSON. Well, it is part of the risk-linked securities

market, and just as you have wind-risk bonds, earthquake-risk

bonds, hailstorm bonds and so forth, you have something called a

second event bond, which would not trigger on the first category

five hurricane that hit Miami, but the second one would trigger it.

And they are usually structure so that you would need two

smaller events like two category four hurricanes to hit in the same

season, which again we can probabilistically model.

Dr. WELDON. Mr. McGhee, based on the diagram on page four of

your testimony, the issuance of catastrophe bonds has decreased or

flattened—is that true? Do you feel that it is a tax issue that is

causing it to happen? Why do you think it is flattening out?

Mr. MCGHEE. It is hard to speculate, because I think there are

a series of things that are feeding into why this marketplace has

stayed relatively flat. The central issue is that catastrophe bonds

are perceived by the potential sponsors of the transactions—insurance companies and reinsurance companies—as still relatively expensive as risk transfer mechanisms.

So essentially it is a cost issue. There is a certain large fixed cost

component to issuing cat bonds. That relatively large fixed transaction cost means that there are a relatively small number of potential issuers because they must be issuing large transactions to

spread that cost over the large transaction size. So it is essentially

a cost issue, and if those costs could be brought down, we think

that the capacity being sought in the capital markets would increase. So it is really a cost issue.

Mr. BRYNJOLFSSON. I would also add that it is my sense, and I

do not have the data to back this up but perhaps one of the other

panelists could verify what I am going to presume and that is, that

recent transactions have tended to be multi-year transactions. This

means that for any given amount of capacity, or for any given

amount of issuance, rather than covering one year of risk, it is covering, say, three years of risk. From a capacity point of view you

could multiply these reported numbers by a factor of three, because

new bonds do not have to be reissued as frequently just to cover

the same risk.

Mr. OZIZMIR. In fact, I believe the number right now of the outstanding capacity in the market is on the order of about $2.5 billion. So even as a dimension, if you issue $1 billion a year and they

are multi-year transactions, over time the actual capacity that exVerDate 11-MAY-2000 11:42 Feb 06, 2003 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 C:\DOCS\84418.TXT HBANK1 PsN: HBANK1
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ists in the market that the reinsurance and insurance companies

can take advantage of is in excess of that.

Dr. WELDON. I believe my time has expired. Madam Chairman,

I did have a follow-up question.

Chairwoman KELLY. Go ahead and ask your follow-up question.

Dr. WELDON. In the GAO report, they have got on page 12, figure 2, Hurricane Andrew was $30 billion, with about $15 billion being

insured and a little less than half uninsured. Northridge was $30

billion.

Then they show the World Trade Center, $80 billion—again

about half is insured, half is not insured. It is very interesting—

they have Kobe, Japan, the 1995 earthquake there, $147 billion of

which $142.9 billion was uninsured. The impression I get is that

relative to the amount of risk we have out there, this may be a

growing segment and in dollar amounts it may be growing.

This is really a drop in the bucket relative to the amount of risk

that is out there. Is that an accurate statement? It sounds like a

good way to try to address the risk, and I am not in any way trying

to knock the industry, but it is not covering a lot of risk.

Mr. BRYNJOLFSSON. Looking at just these four events and the

decade or more they cover, if we were just to average the annual

loss per year, we would be looking at something that appears in

the neighborhood of $30 billion. As pointed out, this market is $2

billion or more. The capital markets in total are typically seen

measured in terms of $30 trillion. So the capital markets clearly

have the ability to absorb $2 billion, as they currently are, or $4

billion or $8 billion or $12 billion of catastrophic risk. Any of those

numbers is not just a noticeable fraction, but a substantial fraction

of catastrophic risk.

Dr. WELDON. So you think the market could absorb the risk—

more of the risk, substantially more?

Mr. BRYNJOLFSSON. Yes.

Dr. WELDON. But as I understand your testimony, and all of your

testimony, the two principal stumbling blocks are the tax treatment and the nature of the market. It is very complicated to get

into and there are a lot of people in the industry who do not have

the expertise or the willingness to get acquainted with the complexity of this type of investment instrument.

Mr. OZIZMIR. Let me add a couple of things to what you said

there. I would add that marginal cost is important. I mean, we discussed the fact that the risk-linked securities market is relatively

small percentage. But in any market, I think the marginal cost is

often what defines the overall price. So I think that we need to look

at the growth of this market in the context of that.

The second thing that I would like to talk about is, we are talking about a lot of knowledge here from the point of view of investors. We at Swiss Re and many other participants in this market

are really not focusing just on knowledge to the investors, but also

to the potential sedants or the insurers who are using this product.

I think that that is something that also needs to grow as well.

For example, there were some conversations here about the NAIC

looking very carefully at how to define basis risk, when it is acceptable and when it is not. That is the same process that we and other

insurers go through when they look at these parametric structures,

24

because since we are not able to sell indemnity risk into the capital

markets as well for the obvious reasons of transparency and disclosure and objectivity, it is important that the knowledge is not just

on the investor side, but also on the user side.

Dr. WELDON. I thank you, Madam Chairman.

Chairwoman KELLY. Thank you. Mr. Ozizmir, how do you relate

the current situation with terrorism to the potential use of the riskbased securities? You mentioned terrorism before.

Mr. OZIZMIR. Yes. Our view at Swiss Re is that the critical element of this market is developing knowledge, objectivity and transparency in how transactions are structured. We feel that terrorism

risk, even away from the securitization process, is not quantifiable.

So if it is not quantifiable in the traditional insurance and reinsurance market, we do not see anything in the near term that

would permit the risk-linked securities market to transfer risk in

the terrorism market.

Mr. MCGHEE. May I just add to that?

Chairwoman KELLY. By all means.

Mr. MCGHEE. I would say that there are a lot of very smart people with lots of initials after their names, like Ph.D., that are working very hard on exactly this problem of terrorism. There are modeling firms that have all recently come out with early, early issues

of models that try to assess the probability of loss of terror attacks.

If those models were to become generally accepted, and we believe this will take some time, then it is possible, we think, that

with time securitization of terror risk is a possibility. But, I should

stress, this is very early days in this marketplace, though there are

many people who are working very hard on this issue.

Chairwoman KELLY. Thank you, Mr. McGhee. I really appreciate

that. We have worked very hard on terrorism and trying to address

the situation, and both of you have shed some light that may help

us along our way, so thank you very much.

I would like to go back to you, Mr. Ozizmir. According to the Institutional Investor last month, several European insurers are now

seriously considering securitization as an alternative source of capital to fund their underwriting capacity. How can reinsurers take

advantage of their unique ability to analyze high-level risk and

work with the securities market and investors to bring confidence

into these deals? What do you think Congress can do to facilitate

this?

Mr. OZIZMIR. I will start with the whole issue, and go back to the

initial issue of knowledge. It is critical that there is transparency

in the transactions. I think it has been mentioned that bringing the

transactions on-shore has various benefits, and we do agree with

that. That said, we do believe that the transactions, the parametric

structures that are currently being done are adequate from a transparency point of view in terms of how the risks are modeled and

how the risks are disclosed.

The critical thing that a reinsurance company needs to do if they

decide to access the capital markets is recognize a few things. One

is that since this is a new market, the cost of getting coverage in

the capital markets is high. In some cases, it is higher than traditional reinsurance; in some cases, it is about the same; and in some

cases slightly lower. But the fact is, it is not a lower cost of covVerDate 11-MAY-2000 11:42 Feb 06, 2003 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\84418.TXT HBANK1 PsN: HBANK1
25

erage. So a reinsurance company needs to make sure that they control and manage the basis risk.

This is a very, very critical issue. The investors, again, are going

to accept transparent modeled objective structures. The reinsurer

or the insurer is going to have their own book of business which

may change in a multi-year period of time. For example, if you do

a four-year structure, much of the reinsurance or insurance you

have written is a one-year contract. So a reinsurer will have to anticipate how their book of business may change over time.

They are also going to have to look very carefully at where their

risk is. We talk about category four hurricanes, category five hurricanes. In the case of Europe, it would be what would be called a

European windstorm would be the predominant risk, such as

Lothar that hit France a few years ago. So the reinsurer needs to,

with the help of the modeling agencies and their own internal analytics, determine at a certain wind speed what their losses would

be. This is a very, very complicated process, but something that

needs to be done.

Chairwoman KELLY. I would like to thank you.

I would like to, Mr. Ozizmir, ask you another question. In your

testimony, you state, reinsurance remains readily available. It

seems to me that any discussion that we have here on reinsurance

capacity ought to cover catastrophic events, ought to include a discussion of the price of covering catastrophic events because price

may mean that reinsurance is not readily available. So I would like

to have you discuss that a bit.

Mr. OZIZMIR. Okay. One of the reasons we do support the development of this market is we agree that prices have increased over

the last few years and in spite of the fact that they increased from

a relatively low level in the late 1990s, clearly capacity coming into

the market will reduce the cost.

We think that that is good for primarily all constituents here in

terms of having greater coverage. That said, the capital markets,

as I said, are not providing distinctly different prices than what is

available in the reinsurance markets right now.

Chairwoman KELLY. We may give you a written question to follow-up on that. I am out of time. Dr. Weldon, have you any other

questions?

Dr. WELDON. Yes, I just have one more follow-up question. Mr.

Brynjolfsson, let’s go back to Miami, category five comes over the

city. Does the catastrophic bonds that we have been talking about

that cover that type of event do anything to help the people who

are living, say, 20 miles south or 20 miles north of the city?

Mr. BRYNJOLFSSON. Sure. The example I gave is actually not specifically part of the contractual nature of the bond. The way the

contract that is written for the specific bond that I was describing

is that if USAA lost more than $1 billion, then the cat bond would

in effect indemnify that insurance company for losses of greater

than $1 billion.

The firms that I alluded to that do the modeling of catastrophic risks were able to quantify for us relatively objectively that $1 billion was high enough a threshold that the insurance company itself

could cover those losses out of the first $1 billion of coverage

through its general operating reserves and the like, and that in

26

order to have more than $1 billion of losses, either one large hurricane hitting a metropolitan area would have to occur, or alternately a smaller hurricane that hit successively three or four or

five communities would have to occur.

For example, if a hurricane went up the coast, it could trigger $1 billion or more in losses. So there is no exclusion of any particular homeowner or anything like that. It is more just a function

of how the industry works. Now, more generally, obviously the way

an insurance company works is they try to write as many premiums as they can without exceeding certain capital constraints.

Any cat bond that helps relieve their capital usage frees up capital

to underwrite in other areas.

The capital markets are, I believe, best equipped to protect

against super-catastrophic risks, meaning those one in one-hundred

year events that I alluded to, and also relatively generic risks

which I as a bond manager can contemplate, understand and have

modeling firms advise me on. Very specific risks relating to the intricacies of workman’s compensation or intricacies of business liability or for that matter even intricacies of terrorism coverage, at

this stage I am not ready to contemplate. I am not saying that I

would never contemplate anything along those lines. However, I do

know on the other hand that I am comfortable contemplating

straightforward simple risks like massive hurricanes and massive

earthquakes.

Dr. WELDON. Go ahead.

Mr. MCGHEE. I was just going to add to that if I could. It touches

back on your question about the size of the cat bond market relative to reinsurance, and it plays in here as well. As Mr.

Brynjolfsson said, the cat bond market really plays in that sort of

super-cat layer, that area in excess of the one in one hundred year

return period.

One of the things that my firm has done is that we have been

looking at the size of risk transfer capacity bought from the cat

bond market and from the reinsurance market in this very remote

area. We believe that there is a relatively small amount purchased

from reinsurance for those super-cat events. It may be as little as

$3 billion in total capacity. If that is the case, then catastrophe

bonds may represent about 40 percent of the overall risk transfer

market in that segment right now. It is a little-understood fact that

cat bonds are a very important part of this super-cat marketplace,

We think cat bonds could actually add significantly to the synthetic

capital that is being created for insurance companies and reinsurance companies that can be then used to provide more coverage to

their policyholders.

Dr. WELDON. I just want to make sure I come away from this

hearing properly understanding this issue. It is a very complex

issue. We have taken testimony that there is a capacity crisis and

then we have taken testimony that there is plenty of capacity out

there. Could you, Mr. Brynjolfsson or Mr. McGhee, answer that

question for me?

Mr. BRYNJOLFSSON. Sure. I would be happy to address that. In

the area of super-catastrophic risk in the area of hurricane risk

and the area of earthquake risk, there clearly is not a capacity crisis. We have been looking to buy catastrophe bonds at spreads that

27

were previously available that are no longer being offered to us because to some extent there is capacity for those types of risk.

On the other hand, and I do not want to get excessively anecdotal, but when it comes to very specific types of risk that I am not

involved in at PIMCO, then there clearly are problems, even in the

area of, well, workman’s comp, other things that were directly

brought to the industry’s attention by the disasters at the World

Trade Center.

For example, the idea that 6,000 people could simultaneously

have their lives put at risk was not something that typical workman’s comp policies had contemplated or life insurance policies

prior to 9-11. My understanding is that air frame and aircraft insurance similarly has become almost unavailable.

Mr. MCGHEE. May I add to that?

Dr. WELDON. Yes.

Mr. MCGHEE. I think you might not characterize it as a crisis,

but it may be a crisis that people do not yet recognize as a crisis,

if I can put it that way. In California, only 17 percent of homeowners have earthquake insurance. In Florida, as you know, there

is a state-sponsored government entity, the Florida Hurricane Cat

Fund, that exists because of the need to intercede and provide

some quasi-governmental support to make homeowners insurance

for hurricanes more readily and cost-effectively available.

So our sense is that there could be much more insurance being

sold to consumers were it available at a competitive cost. We think

that this marketplace could help encourage that—perhaps not solve

all the problems, but could encourage the availability of more and

cheaper capacity.

Chairwoman KELLY. Mr. Ozizmir, I would like you to answer

that question as well, if you do not mind.

Mr. OZIZMIR. Okay. In terms of relating capacity to the impact

of the risk-linked securities market, I would like to basically agree

with what my panel members said. One thing I would highlight

here is that again we are talking about quantifiable, objective and

transparent risks.

Now, for that reason, if you look at the actual secondary market

trading or the spread of new issues on California earthquake, Florida windstorm, European windstorm and even Tokyo earthquake

risks in the market, and if you observe that the trading levels over

the last few years, what you will see is that rates have been pretty

much stable, except for the fourth quarter of last year, after September 11.

What that tells me is that in the types of risks that can be specifically addressed by the risk-linked securities market, there are

capacity issues possibly, but it is not showing up in the trading of

those instruments. Where we are seeing in general the greatest

price increases are the non-quantifiable risks like terrorism, if it is

even available; hull insurance and other things like that for

planes—those have increased dramatically. So again, in the risks

that this market can address, we are not seeing as significant an

increase in price or as great a dearth of capacity.

Chairwoman KELLY. Thank you. Mr. Inslee, do you have any

questions for this panel?

28

Mr. INSLEE. I do. This may be on the periphery of this hearing,

but I wanted to ask about the sort of general assessment of risk

for weather-related losses, and whether the global warming phenomena is causing any concern, any thoughts in the industry in

general.

We see these relatively rapid loss patterns from weather-related

events, and I just wonder, is the industry concerned about global

warming and how it affects catastrophic losses in that regard? Or

is that something you all can comment on? That is a question to

anyone who cares to—if anyone wants to tackle it.

Mr. MCGHEE. Well, I can jump in there. It is absolutely clear

that the reinsurance industry is thinking about just these issues,

and certain large reinsurance companies in Europe have in fact

done some studies with respect to the impact of global warming on

the incidence of natural catastrophe and the severity of natural catastrophe.

I do not think anybody has drawn a firm conclusion as to what

the result will be, but certainly because the reinsurance and insurance industries, they take the hits when they happen, are concerned about this and trying to assess the potential risks associated with global warming.

Mr. INSLEE. Thank you. Thank you, Madam Chair.

Chairwoman KELLY. Thank you, Mr. Inslee. If there are no further questions, the chair notes that some members may have additional questions they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members

to submit written questions to these witnesses and place their responses in the record.

This panel is excused with the committee’s great thanks and

great appreciation for your time. This hearing is adjourned.

[Whereupon, at 3:48 p.m., the subcommittee was adjourned.]

(29)

A P P E N D I X

October 8, 2002

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