A newly formed Bermuda-based reinsurer will provide new insurance industry capacity through traditional reinsurance markets and the capital markets.

Normandy Re president Mr. Aaron Stern said that Bermuda is a logical place for Normandy Re because it is a site for investor entrance into the insurance market.

"The market has been evolving, changing composition initially from a captive market to a broad-based international centre for insurance and reinsurance,'' he said at Deloitte & Touche's Executive International Insurance Seminar.

"Investors are coming in through this market, new investors who had not traditionally been investing in the insurance industry,'' he said. "Banks, mutual funds, hedge funds and others. And the Bermuda regulatory environment is accepting and accelerating development and innovation.

"Normandy Re is located at the convergence of traditional (insurance and reinsurance) and capital markets. There is a blurring of the division between financial entities. This is a broad-based trend, not limited to the insurance sector.

"While there are distinct structural differences, principly in accounting, regulatory and tax issues, Normandy Re's role as an enabler or transformer is potentially limited until accounting issues are resolved and developed.'' Mr. Stern said his company will translate the needs of insurance companies into instruments or securities which can be sold to, and have appeal to, investors.

He saw Normandy Re, formed just last December with a $5 million capital injection from Marsh & McClennan's subsidiary Guy Carpenter, as a dual purpose corporate vehicle.

It is to deal in traditional specialty reinsurance and specific cutting edge financial instruments.

Along with Normandy Re, Guy Carpenter Advisors Inc. is being licensed as a broker/dealer involved with the development of new risk management tools to augment traditional markets and structures and help support and expand existing reinsurance market capacities.

Mr. Stern said that the efforts have been focusing on the development of corporate finances/cost of capital models to help analyse reinsurance as a cost of capital. It would be a substitute for other forms of capital.

Quantitative research efforts are underway to develop information from historical analysis of insurance risk and results, and, financial characteristics and portfolio effects of adding instruments containing insurance risk in investor portfolio.

Mr. Stern said: "In 1994, the approximate property and casualty direct premiums written were US$265 billion. The cat premium element of that was somewhere between $10 and $20 billion. Worldwide premiums are about two and a half times the US total.'' But he said that the financing of catastrophe insurance risk has come from limited pools of dedicated capital, the insurers and reinsurers. The paradox of that capital is that the exposures and revenues from premiums are geographically concentrated.

While diversification on a worldwide basis is inadequate to justify more dedicated capital, one solution is to securitize, allowing for direct investor participation.

The motivation for accessing the capital markets, he said, is the fact that catastrophe exposures have the potential to generate losses in the US in eight different areas between $50 million and $100 million.

At December 31, 1994, US capital and surplus amounted to $190 billion insurers, while for reinsurers it was about $20 billion. It was inadequate to withstand the potential of a dramatic catastrophe.

The US capital markets, on the other hand, had $19 trillion, with some $13 trillion of that in liquid financial instruments, such as US stocks and bonds.

Mr. Stern said, "The appeal to investors are in its portfolio characteristics. The addition of catastrophe risk zero beta asset to a diversified portfolio of stocks and bonds, lowers volatility while enhancing returns.''