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Overview of Risk Securitization. Casualty Actuarial Society Las Vegas March 11-13, 2001. Agenda. Disclaimer Transaction Structures Comparison of Structures, Costs, and Timing Recent Developments in the Securitization Markets Summary.

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slide1

Overview of Risk Securitization

Casualty Actuarial Society

Las Vegas

March 11-13, 2001

agenda
Agenda
  • Disclaimer
  • Transaction Structures
  • Comparison of Structures, Costs, and Timing
  • Recent Developments in the Securitization Markets
  • Summary
slide3

Disclaimer:This presentation has been prepared by American Re Securities Corporation on behalfof itself and associated companies, and is provided for information purposes only. Under no circumstances is it to be used or considered as an offer to sell, or a solicitation of any offer to buy. Neither American Re Securities Corporation nor any affiliate has acted or will act as a fiduciary or financial, investment, commodity trading or other advisor of or for any recipient of this presentation and any investment, trading or hedging decision of a party will be based upon its own independent judgement after consultation with such tax, accounting, legal and other advisors as it deemed appropriate. Although the information in this presentation has been obtained from sources believed to be reliable, we make no representations as to its accuracy or completeness and it should not be relied upon as such. Any opinions expressed herein are subject to change. From time to time, American Re Securities Corporation, its associated companies and any of their officers, employees or directors may have a position, or otherwise be interested in, transactions in any securities directly or indirectly the subject of this presentation. American Re Securities Corporation, or its associated companies, may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any company mentioned in this presentation.The information contained herein is confidential and may not be copied or otherwise reproduced or quoted to any party other than the receiving party (including its directors, officers, employees, or professional advisors in whole or in part).

agenda1
Agenda
  • Disclaimer
  • Transaction Structures
  • Comparison of Structures, Costs, and Timing
  • Recent Developments in the Securitization Markets
  • Summary
slide5

Fundamental Transaction Structure

Investors

Coupon and Principal

Optional

Principal

Premium

Premium

Sponsor

American Re-Insurance

Special Purpose Corporation

Principal

Collateral

Trust

Contingent Claims Payment

Contingent Claims Payment

Interest and remaining principal at maturity

  • American Re-Insurance provides retrocessional coverage for Sponsor
  • American Re-Insurance cedes risk to a Special Purpose Corporation
  • The Special Purpose Corporation fully collateralizes the maximum recovery by issuing debt to the Capital Markets
indemnity cat bond
Indemnity CAT Bond
  • Linked to documented losses of Sponsor in excess of retention
  • Co-insurance is required to avoid ‘Moral Hazard’
  • Requires extensive disclosure
    • Detailed disclosure on business practices and underlying exposures
  • Indemnity transactions are treated as insurance or reinsurance for accounting, regulatory, and tax purposes
  • Bond structure must allow for claims development period:
    • Investors have extension risk
    • No recovery for Sponsor until the end of the development period

Maximum Possible Exposure

Sponsor

Indemnity

Cat Bond

Investors and Insurer

$ Actual Losses ®

Traditional (Re)insurance

Re-Insurers and Sponsor

Retention

Sponsor

parametric cat bond
Parametric CAT Bond
  • Linked to physical event parameters
    • Location
    • Magnitude for Earthquake
    • Maximum windspeed or barometric pressure for Windstorm
  • Introduces basis risk between parametric trigger and incurred losses
  • No co-insurance required
  • Requires minimal disclosure of underlying exposures
  • No extension risk for Investors
  • Less elapsed time before Sponsor’s recovery than for an indemnity bond
  • Treated by the sponsor as a financial contract rather than insurance - subject to derivative accounting under FAS 133

Maximum Possible Exposure

Sponsor

Parametric

Cat Bond

Investors

Magnitude of event ®

Traditional

(Re)insurance

Re-Insurers and Sponsor

Retention

Sponsor

slide8

ModILSSM CAT Bond

Modeled Index Linked Securities: ModILSSM

  • Linked to an Index:
    • Modeled Industry Losses
    • Modeled Sponsor Losses
  • Less basis risk than for a Parametric CAT Bond
  • No co-insurance required
  • Requires disclosure only of the relevant index, not of actual loss potential
  • No extension risk for Investors
  • Less elapsed time before Sponsor’s recovery than for an indemnity bond
  • Treated by the sponsor as a financial contract rather than insurance - subject to derivative accounting under FAS 133

Maximum Possible Exposure

Sponsor

ModILSSM

Cat Bond

Investors

$ Modeled Losses ®

Traditional (Re)insurance

Re-Insurers and Sponsor

Retention

Sponsor

agenda2
Agenda
  • Disclaimer
  • Transaction Structures
  • Comparison of Structures, Costs, and Timing
  • Recent Developments in the Securitization Markets
  • Summary
slide10

Comparison of Structures

ModILS(SM) transactions offer several important advantages as compared to indemnity style cat bonds and parametric cat bonds:

  • Modeled Index Linked Securities (ModILS(SM)) allow sponsors to unbundle the component risks of a catastrophe reinsurance portfolio, and place unbundled risks with the most efficient investor:
    • Modeled Cat Risk with the Capital Markets
    • Basis Risk/Claims Adjudication Risk with Specialists (Sponsor or Reinsurer)
  • ModILS(SM) are more efficient at transferring modeled risk than indemnity bonds due to lower “uncertainty haircuts”
  • More transparent risk analysis of ModILS(SM) should appeal to a broader universe of capital markets investor
  • ModILS(SM) transactions offer sponsors lower basis risk as compared to parametric style cat bonds
slide11

ModILSSM

In addition to quantitative risk transfer improvements due to unbundling of risk, Modeled Index Linked Securities offer other benefits to both sponsors and investors:

Sponsors:

  • Less complex disclosure requirements
  • Less invasive rating agency process
  • Minimal senior management involvement in execution and marketing
  • No claims verification expense, no explicit exposure to ‘tail’ risk
  • Relatively rapid recovery period

Investors:

  • No operational exposure to claims adjudication process
  • No potential for lengthy claims development period
  • No basis risk between disclosed modeled exposures and actual exposures, with respect to both:
    • Initial Disclosure
    • Portfolio drift over time
what are the pros and cons of securitization
What are the pros and Cons of securitization?

PROS:

  • Diversification of risk transfer and access to new capital
  • Cash collateralized protection, no counterparty exposure
  • Potentially lower costs and greater capacity

CONS:

  • Longer implementation time
  • Potential accounting issues
  • Potentially higher costs
who buys cat bonds
Who Buys CAT Bonds?

Some Past Investors:

  • Bank of Montreal
  • Bracebridge Capital
  • Capital Research and Trading
  • Combined Insurance Company of America
  • Everest Re
  • John Hancock Mutual Life
  • Lazard
  • Lincoln Re
  • Lutheran Brotherhood
  • Pacific Life
  • PIMCO
  • Renaissance Re
  • TIAA
  • Travelers
  • US Fidelity & Guarantee

Mutual Funds

Life Insurers

Hedge Funds

Reinsurers

Banks

Non-Life Insurers

what are the costs of a securitization
What are the costs of a securitization?
  • Initial transaction costs are constant for any transaction of $100 million in size or less:
  • Ongoing transaction costs depend on the maturity of the bond. The following estimates are the spread to LIBOR demanded by Capital Markets investors for BB risk:

1 Year 3 Year 5 Year

500 bps 525 bps 550bps

what are the costs of a securitization1
What are the costs of a securitization?
  • All-in, estimated transaction costs, expressed as an annual Rate-on-Line:
what is the implementation time frame
What is the implementation time frame?

Indemnity Bond

ModILS SM or Parametric Bond

agenda3
Agenda
  • Disclaimer
  • Transaction Structures
  • Comparison of Structures, Costs, and Timing
  • Recent Developments in the Securitization Markets
  • Summary
slide19

The market for securitization continued to be active

in the year 2000:

  • Volume is 23% higher in 2000 than in1999
  • Spreads are wider for equivalent risks, in line with the high yield bond market
  • Significantly, investor demand for higher risk cat bonds has begun to develop
slide20

Several new participants have approached

the capital markets:

  • State Farm
  • SCOR
  • Munich Re
  • Lehman Re
  • Vesta Insurance Group
  • AGF
issuance volume
Issuance Volume
  • 1999 Transactions include:
    • Issuer Bond Size Sponsor Peril Estimated Annual Premium*
    • Domestic Inc. $100 Kemper New Madrid EQ $4.6 million
    • Concentric, Ltd. $100 Tokyo Disneyland Tokyo EQ $3.5 million
    • Circle Maihama $100 Tokyo Disneyland Tokyo EQ $1.2 million
    • Halyard Re $17 Sorema European Wind $1.8 million
    • Residential Re $200 USAA U.S. Windstorm $8.5 million
    • Juno Re, Ltd. $80 GKG U.S. Windstorm $4 million
    • Mosaic Re II $45.7 F&G Re Diverse U.S. $3.6 million
    • Gold Eagle Capital $182.1 American Re Diverse U.S. $12 million
    • Namazu Re $100 GKG Japanese EQ $7.2 million
    • TOTAL $924.8 $46.4
  • 2000 Transactions include:
    • Issuer Bond Size Sponsor Peril Estimated Annual Premium*
    • Atlas Re $200 SCOR Diverse Worldwide $24 million
    • Seismic, Ltd. $150 Lehman Re California EQ $10.5 million
    • Halyard Re (Remarketing) $17 Sorema European Wind $1.5 million
    • Alpha Wind $89.5 Arrow Re/State Farm U.S. Windstorm $6.8 million
    • Residential Re $200 USAA U.S. Windstorm $10 million
    • NeHi $50 Vesta U.S. Windstorm $2.6 million
    • Mediterranean Re $129 AGF Eurowind & Monoco EQ $9 million
    • PRIME Capital Hurricane $168 Munich Re U.S. Windstorm $14.5 million
    • PRIME Capital CalQuake & Eurowind $138 Munich Re Eurowind & Calif. EQ $14 million
    • TOTAL $1,141.5 $92.9

*Estimated Annual Premium is a rough estimate based on incomplete information, and includes assumptions about upfront costs, as well as an amortization schedule of said upfront costs, and may include costs of equity or other costs believed to be included in a transaction. The estimated annual premium is the amount it is expected an entity would need to pay on a third party basis using the up-front fees typical of a major investment banking institution.

bond market association initiative
Bond Market Association Initiative
  • The Bond Market Association, a prominent trade association of Wall Street dealers, has formed a Committee on Risk-Linked Securities to promote the continued growth and development of the market for risk-linked securities. Current Agenda includes the following items:
    • A subcommittee to further standardize documentation to enable DTC/Euroclear eligibility.
    • A subcommittee to organize an industry conference focused on risk-linked securities, with a particular emphasis on educating investors. This is scheduled to take place March 21 to 23 in Miami, Florida.
naic discussions
NAIC Discussions
  • The NAIC has formed an Insurance Securitization Working Group and Reinsurance Task Force
  • Discussions have centered around the extent to which and conditions under which the NAIC should endorse the following issues
    • On-shore special purpose vehicles for securitization
    • Re-insurance like accounting treatment for non-indemnity derivative products
  • The NAIC Insurance Securitization Working Group has approved a model act to permit on-shore SPRVs (Special Purpose Reinsurance Vehicles) to facilitate risk securitizations. This will be considered by the full NAIC in June 2001, however additional tax legislation is necessary to make on-shore risk securitization a practical alternative to current off-shore structures.
  • NAIC appears likely to endorse re-insurance like accounting for derivatives only after effective risk transfer has been demonstrated. This may only apply to fully collateralized derivatives.
    • This may mean that catastrophe risk derivatives will receive investment treatment unless collected upon, in which case successful risk transfer is demonstrated and the derivative receives underwriting treatment
trends to watch
Trends to Watch
  • Recent academic studies have continued to assert that there is no fundamental, theoretical reason to expect that catastrophic risk pricing will increase(1).
  • Studies such as these continue to assert that catastrophic risk pricing should minimally exceed the actuarially predicted expected loss of a contract plus expenses, when held as part of a diversified portfolio of risks.
    • What will be the ultimate impact of the capital markets on reinsurance pricing?
    • Who is ultimately the most efficient taker of catastrophe risk?
  • Press reports and rating agency studies continue to suggest significant growth potential and continuing pressures on reinsurance pricing
  • Certain recent transactions as well as the CEA’s current issuance of a catastrophe bond to replace a portion of their traditional program appear to be competitive with reinsurance pricing as insurance and reinsurance rates continue to firm

(1) Froot, Kenneth, and Steven Posner. “Issues in the Pricing of Catastrophic Risk” Marsh & McLennan Securities Corporation and Guy Carpenter& Company, Inc. May 2000 Special Report.

Froot, Kenneth, “The Limited Financing of Catastrophe Risk: An Overview,” The Financing of Catastrophe Risk, University of Chicago Press, in Press.