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Cover and the capital markets

Much has been said about convergence between the insurance and capital markets. But what legal issues are involved? By Christopher Stoakes

Investment bankers have been eyeing up the insurance market for some time. The small size of the reinsurance market ­ estimated at no more than a few hundred billion dollars ­ means it lacks the capacity to absorb a succession of catastrophic risks. If the capital markets, whose capacity runs to tens of trillions of dollars, can be tapped, there is money to be made by intermediating bankers. Some have invested in the development of suitable financial products, including research of the legal issues, to determine what they can sell the insurance industry.

The starting point is to look at insurance companies as asset managers. Insurance, like banking, is a regulated industry. Regulators consider it their duty to protect policyholders. They restrict the assets that insurance companies can value for solvency purposes, to prevent mismatches with liabilities and ensure that assets are prudently managed. Before the implementation of the EC Third Life and Non-Life Directives in July 1994, derivatives were not widely used by insurance companies because they could not generally include them when determining their solvency margins. The directives recognize that insurers can benefit from limited and prudent use of derivative products and provide that the value of derivatives held "in so far as they contribute to a reduction of investment risks or facilitate efficient portfolio management" can be used to cover liabilities.

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