The Global Financial Crisis – risk transfer, insurance layers, and (lack of?) reinsurance culture

Abstract

The Global Financial Crisis of 2007–2008 has elicited various debates, ranging from ethics over the stability of the banking system to subtle technical issues regarding the Gaussian and other copulas. We want to look at the crisis from a particular perspective. Credit derivatives have much in common with treaty reinsurance, including risk transfer via pooling and layering, scarce data, skewed distributions, and a limited number of specialised players in the market. This leads to a special mixture of mathematical/ statistical and behavioural challenges. Reinsurers have been struggling to cope with these, not always successfully, but they have learned some lessons over the course of more than one century in business. This has led to certain rules being adopted by the reinsurance market and to a certain mindset being adopted by the individuals working in the industry. Some cultures established in the reinsurance world could possibly inspire markets like the credit derivatives market, but the subtle differences between the two worlds matter. We will see that traditional reinsurance has built-in incentives for (some) fairness, while securitisation can foster opportunism.