A leading authority on securitisation of insurance risk said there is strong evidence which points to a future where risk is traded like any other commodity.

Speaking on Thursday at the Bermuda Insurance Symposium, Richard Sandor, former chief economist for the Chicago Board of Trade (CBT), said history shows change stimulates financial innovation.

There have been big structural changes and "I think securitisation will change the face of the insurance business as we know it.'' Securitisation, or the trading of property catastrophe risk using financial instruments such as options and bonds, enables insurance companies to hedge exposure.

Mr. Sandor is president and CEO of CNA's Hedge Financial Products Inc. Under a reorganisation, Centre Financial Products Ltd., which was recently acquired by CNA, will become Hedge Financial Products. Hedge Financial will use the capital markets to create innovative insurance coverage.

Mr. Sandor helped develop the interest rate futures market and created the first CBT insurance futures and options contracts.

As evidence that insurance and capital markets will converge, Mr. Sandor pointed to financier Warren Buffett's taking $1.5 in reinsurance capacity in the California Earthquake Authority (CEA) -- that layer was to be catastrophe bonds.

"What is nominally called a failure, we consider a success,'' Mr. Sandor said.

"I consider Buffett the most astute man in the world with regard to investing. If Buffett thinks Cat risk belongs in an investment portfolio shouldn't other money managers also consider securitised insurance risk to their portfolios?'' Mr. Buffett committed $1.5 million in capacity to the $10.5 billion CEA for premium of $590 million with attachment at $7 billion in homeowners claims.

Term is four years. Northridge would have resulted in $4 billion in claims.

The estimated probability of occurrence over a one year period is 1.27 percent.

Mr. Sandor also said that insurance and capital markets will converge because of the imbalance between insurance capital and US assets.

"Capital currency available in the insurance markets does not support the asset base in the US.'' US gross domestic product plus US property value is estimated at $18 trillion to $21 trillion while US primary insurance capital, US reinsurance capital and Lloyds and other capital total $240 billion.

A.M. Best estimates the present value of US environmental liabilities at $26 billion leaving net insurance capital of $214 billion to support as much as $21 trillion in US assets.

Another argument supporting convergence is that there has been an increase in severity and frequency of worldwide insured catastrophe losses, he said.

The three largest catastrophes have hit relatively minor areas, "Kobe hit Kobe, not Tokyo'' and every few years there seems to be a "storm of the century.'' Mr. Sandor also said that the US Federal Reserve is acknowledging the practicality of new products which link capital and insurance markets.

"The trading of property catastrophe risk using standard financial instruments such as options and bonds enables insurance companies to hedge their exposure by transferring risk to investors, who take positions on the occurrence and cost of catastrophe.

"Although these property catastrophe risk instruments are relatively new products, they have already established an important link between the insurance industry and the US capital market,'' the Federal Reserve Bank of New York said.

For now, securitisation is growing in "fits and starts,'' Mr. Sandor said.

PCS catastrophe insurance options, first traded in September 1995, have grown to over 11,000 contracts last month.

Ultimately, securitisation could be a 20 year process. Over that time, financial products will morph into securitised products, he predicted.

But capital markets should not find securitisation of insurance difficult to grasp, he said.

Though some cat bonds were not successful, it should be remembered that the attempt to securitise mortgages in the US took 20 years. And over time, the definition of commodities has expanded, he said.

Up until the 1960s, the prevailing wisdom had been that only principle storable bulk commodities were the only things that lent themselves to trading.

In the 70s, a new definition emerged and that included the term tangible. "We asked that anything intangible be added.'' And who holds the key to unlock the capital markets? Reinsurance companies, Mr. Sandor answered.

"They have the keys to the kingdom, They are the natural player. They are the investment banks of the future. Reinsurers have to get unanimously excited.

Nobody has a head start. It's not complicated. You can all master it. The philosophy is simple.'' BUSINESS BUC