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Securitisation: a tool for improving capital management and risk management in the European Insurance industry. Jean-Christophe MENIOUX Director of Financing / AXA Group Treasurer. A.L.A.C. Seminar Luxembourg, October 16th 2007. Table of contents.

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Securitisation: a tool for improving capital management and risk management in the European Insurance industry

Jean-Christophe MENIOUXDirector of Financing / AXA Group Treasurer

A.L.A.C. Seminar

Luxembourg, October 16th 2007


Table of contents
Table of contents risk management in the European Insurance industry

1 : The transformation of the insurance business model

2: AXA, a pioneer in the transformation of the model

3: How to develop further the ILS market ?

4: Case study: SPARC Europe (June ’07)


The transformation of the insurance business model from warehousing risks
The transformation of the insurance business model risk management in the European Insurance industryFrom warehousing risks ...

Insurance business model based on warehousing risks:

Risks taken from policyholders

Risks pooled and borne by the insurers

Traditional reinsurance programs

Requiring large diversificationand good underwriting

Requiring a relatively large amount of capital, not always efficiently used

The Old World

  • Focus on product returns without properly measuring risk/volatility

  • Management of assets independent from management of liabilities

  • Accounting rules far from “marked-to-market”

  • Few rated companies

  • Few institutional investors


The transformation of the insurance business model risk management in the European Insurance industry... to understanding, restructuring and transferring risks (1/2)

Business model evolving towards management &intermediation of risks:

  • Risks taken from policyholders

  • Risks pooled and structured by the insurers

  • Risks externalized through reinsurance programs & financial markets

    Requiring efficient diversification

    Requiring moderate amount ofcapital with appropriate capital management

The New World

  • Focus on products’ risks / value

  • Integrated assets / liabilities management

  • Accounting rules closer to “marked-to-market”

  • Many rated companies

  • More institutional investors


The transformation of the insurance business model risk management in the European Insurance industry... to understanding, restructuring and transferring risks (2/2)

Risks can be insured = Risks can be restructured

Market risks being more dynamically managed through the use of suitable hedges (bought or built):

UL with guarantees

General Account embedded options

Insurance risks being externalized through:

Financial markets

Reinsurance markets

Other risks still being kept and borne by insurers:

Scale (mutualisation of risks)

Requirement of a specific expertise

Prohibitive market prices


Table of contents1
Table of contents risk management in the European Insurance industry

1 : The transformation of the insurance business model

2: AXA, a pioneer in the transformation of the model

3: How to develop further the ILS market ?

4: Case study: SPARC Europe (June ’07)


Securitisation a modern tool to improve risk and capital management 1 2
Securitisation: a modern tool to improve risk and capital management (1/2)

Banks have started to actively use securitisation as a risk management or a capital management tool since the eighties, which led to a successful transformation of the banking industry.

Commercial banking ROE(1984 – 2004)

ABS/MBS Outstanding in the USin USDbn

Non-mortgage ABS outstanding

MBS and Mortgage ABS outstanding

Source: Morgan Stanley

Note: Non-mortgage ABS only included from 1995

Source: Stone Point Capital


Securitisation a modern tool to improve risk and capital management 2 2
Securitisation: a modern tool to improve risk and capital management (1/2)management (2/2)

Securitisation of insurance risk is a recent phenomenon, beginning slowly in the mid-nineties with the issuance of the first catastrophe bonds, and continuing in the 2000’s with some securitisations of embedded value.

Most recently, risk securitisation continued to expand with some innovative transactions:

  • Mortality risk (Vita I in 2003 from Swiss Re ; Vita II in 2005 ; Osiris from AXA and Tartan from Scottish Re in 2006 ; Vita III in 2007)

  • P&C insurance risk (Sparc France in 2005 and Sparc Europe in 2007 on AXA’s motor portfolio)

     But the insurance sector is lagging behind the banking industry (in Europe, in 2006, € 450bn new issues for ABS/CDO vs around $ 9bn Insurance Linked securities worldwide)

Total ILS outstanding as of 25 Jun 07, in USDbn

Source: Swiss Re


Axa is a pioneer in risks restructuring risk transfer

A+ to BB+ management (1/2)

Private

SPARC France

AURA Re

OSIRIS

AAA to BB-

AXA is a pioneer in risks restructuring & risk transfer

  • Securitization and dynamic Asset Liabilities Management are the new tools for risk management and capital management, aiming to :

    • Improve capital utilization in the insurance industry

    • Broaden the range of available tools for risk management and balance sheet optimization

    • Diversify reinsurance sources away from traditional reinsurance market while eliminating counterparty risk

    • Develop Insurance Linked Securities as a new asset-class for investors

  • Examples of AXA’sinnovative Life & P&Cinsurance-linked securities (ILS) transactions

    • AURA Re (2005): European storm Cat bond (€68m)

      • Protects the group against low frequency-high severity European Windstorm events

    • SPARC France (2005): 1st securitization of a motor insurance portfolio (€200m)

      • Transfers the risk of deviation above a certain threshold of the loss ratio of the securitized portfolio

    • OSIRIS (2006): 1st extreme-mortality risk coverage program from an insurance company (€300m)

      • Protects from a sudden jump in the mortality rate in 3 countries (France, Japan, US) which would accelerate payments on our term life policies

    • SPARC Europe (2007): 1st securitization of a multi-jurisdiction motor insurance portfolio (€450m)

      • Transfers the risk of deviation of the loss ratio on a diversified portfolio of motor books in Germany, Belgium, Spain and Italy

AAA to BBB

SPARC Europe


Table of contents2
Table of contents management (1/2)

1 : The transformation of the insurance business model

2: AXA, a pioneer in the transformation of the model

3: How to develop further the ILS market ?

4: Case study: SPARC Europe (June ’07)


From traditional reinsurance to the full spectrum of capital market solutions

Indemnity securitization management (1/2)

  • rated

  • public placement

EV securitization

  • rated

  • public placement

  • cash proceeds + collateral

From traditional reinsurance to the full spectrum of capital market solutions

“Pure traditional” solutions

“Pure ILS” solutions

Industry loss securitization

  • rated

  • collateralized

  • customized industry loss

Traditional reinsurance

  • not rated

  • not collateralized

  • indemnity based

ILW or derivatives

  • not rated

  • modelled loss or parametric index

  • maybe collateralized

Parametric securitization

  • rated

  • public placement

  • customized parametric index

Source: Swiss Re


Key advantages of securitization
Key advantages of securitization management (1/2)

Capital markets have significantly greater capacity than insurance markets

Better pricing in some cases where insurance market has a limited number of providers

Removes counterparty credit risk

Increases the diversification of protection sources and offers multi-year protection

Improves the cost of capital, i.e. the reduction in the cost of capital achieved through securitisation is greater than the cost of servicing the securitisation structure

 There is a considerable potential market for ILS, as the need for risk transfer from insurance companies matches the desire for diversification from investors as insurance risk is an uncorrelated new asset-class


Key success factors for developing securitization
Key success factors for developing securitization management (1/2)

  • Need to fully recognize risk transfer and allow capital relief

  • Not differentiate b/w reinsurance, ILS or derivatives at equal risk transfer

  • Accept SPVs as valid counterparties not subject to stringent solvency requirements

  • No restrictions on institutional ILS investments

Regulators:

  • Need to fully recognize risk transfer and allow capital relief

  • Value securitization and other forms of risk transfer in their assessment of quality of risk management

  • Increase transparency on process for rating notes

Rating agencies:

  • Education of market participants to transfer and to accept more and more sophisticated risks

  • Increased transparency on modelling, documentation, data (standardization of contracts, SPVs, triggers)

  • ILS indices to develop derivatives and secondary market

Capital markets:


Table of contents3
Table of contents management (1/2)

1 : The transformation of the insurance business model

2: AXA, a pioneer in the transformation of the model

3: How to develop further the ILS market ?

4: Case study: SPARC Europe (June ’07)


Sparc europe objective and outcome
SPARC Europe - Objective and outcome management (1/2)

The objective is to securitize the risk of deviation of the cost of claims of AXA individual motor portfolio in 4 countries

  • € 2.6bn earned premiums, 6 million contracts

  • High granular portfolio: high frequency, low severity and low volatility

  • Around 1,500,000 claims p.a.

    Key outcome for AXA

  • Transfer of € 450 million risks over 4 independent cover periods (2007 to 2010)

  • Average margin in line with similarly rated synthetic Asset Backed Securities (ABS) securitizations

  • Diversification of the sources of reinsurance outside of traditional markets while eliminating counterparty risk

  • New asset-class offered to traditional ABS investors in 4 tranches (from AAA to BB)

  • Improved balance sheet efficiency and capital management


Sparc europe deviation of the loss ratio
SPARC Europe – Deviation of the Loss Ratio management (1/2)

The transaction, structured via two SPVs, is similar to a synthetic securitisation by which the risk of performance of the 4 mutualised motor insurance portfolios (forming the Global Portfolio) is transferred to investors at certain defined levels

The performance is measured via the Global Loss Ratio:

The main risk for investors is the deviation of the Global Loss Ratio above the Global Loss Ratio Trigger Level

∑ Claims

∑ Earned Premiums

Principal for each class of notes is at risk in the event of Global Loss Ratio exceeding an annual Global Loss Ratio Trigger Level.

G

l

o

b

a

l

L

o

s

s

R

a

t

i

o

Notes issued by SPARC EUROPE

Assets held by SPARC EUROPE

4 Senior deposits

EUR 91,500,000 Class A

AAA/AAA

S&P/Fitch

Target Global Loss Ratio + 20.0%

EUR 220,000,000 Class B

A/A+

S&P/Fitch

SPARC EUROPE

(Senior Issuer)

Target Global Loss Ratio + 9.9%

EUR 100,100,000Class C

BBB-/BBB

S&P/Fitch

Target Global Loss Ratio + 5.3%

EUR 39,200,000 Class D

BB/BB-

S&P/Fitch

1 Joint Junior deposit

SPARC EUROPE

(Junior Issuer)

Target Global Loss Ratio + 3.5%

Equity Notes

Target Global Loss Ratio equal to 69.0%


Sparc europe a structure similar to a synthetic securitisation

FCC SPARC management (1/2)

SPARC Europe - A structure similar to a synthetic securitisation

AXA S.A

NATIXIS

GROUP

Direct payments in advance for cost of funds of the Senior and Junior Issuers

Quota share treaty

Secured Financial Instruments/Guaranteed Investment Contract

Premiums

AXA

Germany

Claims + reinsurance

commission

Senior + Joint Junior Deposit

Sale of the receivables

Placement

Quota share treaty

Premiums

Recoverable on each Insurer against the

Senior Secured Deposits

FCC SPARC

Senior Issuer

AXA

Belgium

Claims + reinsurance

commission

Notes

AAA/AAA Notes

AAA/AAA Notes

Qualified

A/A+ Notes

A/A+ Notes

investors

Senior + Joint Junior Deposit

BBB-/BBB Notes

Euro 411,6 Million

Proceeds

Euro 411,6 Million

BBB/BBB

-

Notes

Quota share treaty

Premiums

NEXGEN RE

Claims + reinsurance

commission

AXA

Italy

Recoverable on the Insurers against the Joint Junior deposit

Notes

Qualified

investors

Junior Issuer

Senior + Joint Junior Deposit

Proceeds

Euro 39,2 Million

Quota share treaty

BB/BB- Notes

Equity tranche

Premiums

Euro 39,2 Million

AXA

AXA

Spain

Claims + reinsurance

commission

Senior + Joint Junior Deposit


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