First, they help evaluate the risk of the catastrophe bond and assign a rating, which is very important in terms of enhancing the appeal of the bond to potential investors. On the other side of the coin, rating agencies play an important part in setting benchmarks for each company's permissible level of exposure to capital and earnings volatility. Because of the agencies' requirement that companies protect themselves against such exposure, a certain level of catastrophe reinsurance is needed. In some cases, these hurdles create a greater need for securitization. This was done through the exchange of two traditional reinsurance contracts.
Coverage is triggered on a parametric basis, rather than by a monetary amount of loss.
This exchange of risks is an innovative way to efficiently manage peak risk exposure. Guy Carpenter's Instrat group has developed financial modeling techniques to assist companies in quantifying the net cost and benefits of using a swap transaction instead of other risk hedging techniques, such as traditional catastrophe reinsurance. Guy Carpenter and Marsh Securities are currently working on a half dozen or more swap arrangements. We expect that swaps will occur more frequently in the future, as companies become more proactive in managing their global catastrophe exposures on an overall portfolio basis. What might trigger an increased interest in securitization, however, is the next mega-catastrophe.