A new division has been formed by Commercial Risk Partners Ltd. to take advantage of the converging insurance and capital markets.

Commercial Risk Capital Markets will develop new products utilising both the distribution of insurance risk into the capital markets and the use of tradeable derivative instruments.

The company is recruiting a specialist team, to be in place in Bermuda by the fourth quarter. They will focus on product development and invest in a full range of insurance-linked securities.

Legal, actuarial and traditional underwriting skills are required to conduct this business. Commercial Risk already has such resources to work with a capital markets team.

But the firm will need to hire two additional staff, including a team leader, with an investment banking background who have specialty skills dealing in derivatives.

Jacques Blondeau, chairman of Commercial Risk, and its parent French reinsurer, SCOR, commented: "It is clear that the capital markets have a role to play in the distribution of insurance risk and this initiative will ensure that SCOR Group are in a position to offer to offer a full range of products to its clients.'' President and CEO of Commercial Risk Graham C. Pewter said, "This sector of the market is growing rapidly in importance and our involvement is a natural evolution of our business as a provider of non-traditional capacity to the market.

"To an increasing degree, reinsurers will act as a bridge between the insurance and capital markets and we believe it is vital to build the necessary expertise in the management of basis risk across a full spectrum of exposures.'' Traditionally, basis risk is the risk of a change in price as a result of a change in yield-to-maturity. It can also be considered to be the risk of an unfavourable basis change that results in a futures gain less than a cash market loss, or a futures loss that is greater than a cash market gain.

Commercial Risk is already moving on some related projects that need not wait until the full complement of the new division is in place.

The firm will develop new products through the use of derivatives to hedge exposures. Weather derivatives, for example, can be used to provide coverage to the market that might protect a client's earnings against losses that may be weather-related.

Firms offering this type of cover would offer a contract to a power generating company to protect its earnings against the possibility of a loss of earnings because of a cool summer that produced less demand for energy to power air conditioners.

Here, Commercial Risk might hypothetically be able to offer such a contract, but then also hedge their risk by buying a weather derivative based on if it will be a cool or hot summer.

Said Mr. Pewter, "It has to be a very strong correlation between the underlying exposure in our contract and the derivative that we would be looking to buy, to hedge our position.'' This way, when risk takers lose, by having to pay insureds because the weather was cool, they can get at least some of it back from the hedge product that was purchased to back up the underwriting.

Because its is not perfect, there always remains the risk (the basis risk) that the recovery under the hedge does not completely cover the underlying loss to the client.

Mr. Pewter added, "Building skills in managing basis risk across different types of exposure classes is an important part of this project, and a natural evolution of what we do.'' Commercial Risk expects the new division will be offering property catastrophe-related capacity to clients, and using the capital markets to hedge their own exposure through cat bonds or swaps.

Most of the catastrophe-related business has been concentrated in the US, but Commercial Risk also sees future opportunities in Japan and Europe.

"We will be working through the SCOR network,'' said Mr. Pewter. "SCOR has a subsidiary network of offices around the world. We will be working with them, particularly those in the Far East and Europe to develop these types of products.

"We also expect an expansion of risks to go beyond the property cat field into other lines of business. The cat area has been were most of the historic activity has been, and where there will continue to be a lot of activity.

"But we expect other lines of business to be embraced by the capital markets as well.'' Commercial Risk is a joint venture of SCOR and Western General Insurance Ltd.

It is a specialist insurer and reinsurer that underwrites an international portfolio of business through operating subsidiaries in Bermuda, the US and Luxembourg.

A leading participant in the Alternative Risk Transfer market, Commercial Risk's clients are corporations and insurers who seek alternatives to traditional insurance and reinsurance mechanisms in order to manage risk.

GRAHAM C. PEWTER -- "This sector of the market is growing rapidly in importance and our involvement is a natural evolution of our business as a provider of non-traditional capacity to the market.''