This is the abstract of my seminar presentation, which took place at Korea Law Institute, Korea University on October 30, 2004.

Risk securitization, or securitization of risk of loss from future events, generally provides alternatives, through the capital markets, to traditional reinsurance. The capital markets provide a source of risk-taking capital for reinsurers and, in some cases, non-insurers with risks through catastrophe bonds or CAT-bonds.

Securitization of insurance risks is different from traditional asset securitization in that a contingent liability, not a pool of assets, is the principal subject of the transaction. However, the structuring scheme of CAT-bonds is almost similar to that of ordinary asset-backed securities. In other words, CAT-bonds seem to be one of those alternative risk transfers (ART).

CAT-bonds were created in response to the lack of reinsurance capacity and rising reinsurance premiums for losses resulting from natural catastrophes, for instance, Hurricane Andrew of 1992, California Northridge Earthquakes of 1994 and winterstorms in Europe. Recently catastrophe losses have increased remarkably owing to the rapid changes of global environment, swelling population and industrial concentration in the critical areas.

Aside from spreading potential losses more widely through the capital markets, risk securitization provides the additional advantage of moderating price volatility of reinsurance and bringing improved stability to the insurance industry. Moreover, CAT-bonds are correlated with major capital market indices and thereby offer greater diversification potential together with lucrative, but sometimes speculative, investments to investors. Risk securitization also offers reinsurance features often not available from traditional reinsurers, such as multi-year cover. So insurers can use CAT-bonds to lock in attractive long-term rates.

In Korea, the CAT-bonds are likely to be a hot issue in the near future, because Korean farmers are occasionally plagued by floods, typhoons and droughts, and Korean businessmen are ready to invest in North Korea. But for adequate cover of reinsurers, the current projects under consideration might be put aside because of the limited coverage of the Loss Compensation Program provided by Korea Export Import Bank.