Longevity Risk from the Perspective of the ILS Markets

1. Longevity Risk from the Perspective ofthe ILS Markets Morton N Lane Ph. D. Director, M Sc in Financial Engineering, University of Illinois President, Lane Financial LLC Sixth International Longevity Risk and Capital Markets Solutions Conference September 9,10th, 2010 Swiss-Grand resort and Spa, Bondi Beach, Sydney, Australia

2. Longevity Risk from an ILS Perspective - Size • The Natural Catastrophe Market is tiny compared to Life • Accumulated Issuance* in the past 15 years is $30 - $40 Billion • $12 Billion is currently outstanding • About 10% of the issuance has been in Extreme Mortality • * The universe under consideration is all bonds that contain a risk analysis, i.e. where there is an Expected Loss

3. Longevity Risk from an ILS Perspective; Exchange, Origins • The ILS market started with the Loss from Hurricane Andrew • in 1992. A market born out of disaster and commercial necessity • Its first incarnation was an Exchanged Traded Option (at CBoT) • The CBoT market died after 5 Years (Soft Market) • Since then, Exchanges have been tried in New York, Bermuda • London and again in Chicago. All would have enabled public • access. • None has (robustly) succeeded • The wrong Economics? Auctions?

4. Longevity Risk from an ILS Perspective - Indices • The following loss measures have been used on the Exchanges, • Loss ratios • PCS Industry Numbers (by region and proportionate to loss) • Guy Carpenter (customizable) loss ratios • PCS Industry Numbers (by region and binary event) • Hurricane Index formula (based on storm Intensity)

5. Longevity Risk from an ILS Perspective - Indices • Private transactions have used all the preceding loss indices • plus, Sigma, Munich Nat Cat Services, plus • PCS Industry Numbers (modeled to book), PERILS • Parametric earthquake measures, Wind speeds • Paradex, AIR, Modeled Loss, Computer modeled replications • of cedants book • To paraphrase Lance Armstrong, Its not about the Index • Its about the need – or opportunityIf the need is there, • almost any index will do – Cat in the Box • Better Indices are good, but will not provide the tipping point. • 20-30% of annual issuance remains indemnity based.

6. Longevity Risk from an ILS Perspective – Event Driven • The development of Cat bond has been event driven more • than anything else. • What are the extreme events that will drive Longevity risk? • Two that I believe stimulated the first mortality bonds were, • Terrorism (dirty bombs) andPandemics • Swiss Re issued the first Mortality Bond the year after the • SARS outbreak and a little over 2 years after 9/11

7. Longevity Risk from an ILS Perspective – Event Driven • Nearly 90% of all Cat ILS are Occurrence based • Aggregate covers, even erodible thresholds are not popular • They are subject to greater secondary market fluctuation • What are the “Occurrence” event risks that need be transferred • by annuity/pension providers? • Cure for Cancer, Diabetes Pill, Shifts in Trend?

8. Longevity Risk from an ILS Perspective – Capital or Risk? • If the longevity risk has to be transferred because of mandate • or a desire to write or hold a bigger book • A sidecar, or quota share to a more appropriate analog than ILS • Sidecars have worked well to increase capacity in a hard • market. They do not serve to reduce risk in the retained book • Sidecars are not wanted when capital is plentiful • (even to generate fees) • Swaps which substitute fixed for floating seem like finite • reinsurance?

9. Longevity Risk from an ILS Perspective – Bonds or Swaps • MostILS issuance has been done in the form of Bonds not Swaps • Bonds allow for distribution to many investors; Swaps tend to be • private 1:1 transactions or club transactions • Swaps depend on the rating of the counterparty, not the swap itself. • Also, if they need to be reversed, its usually the same counterparty • Bonds Ratings make for wider investor based distribution • Separately rated tranches also allow access to conservative and • more risk taking investors. Specialist and opportunistic investors • Rated Bonds also allows secondary market trading – necessary • for hedge fund valuations • Liquidity for all investors is in very high demand

10. Longevity Risk from an ILS Perspective – Bonds or Swaps • ILS structures have eschewed swaps since the Lehman Default • 90% of all issues since the end of 2008 have avoided swaps (prior • to 2008, 90% contained swaps) • Where swaps are used they heavily collateralized and managed • ILS investors at present do not want counterparty credit risk

11. Longevity Risk from an ILS Perspective - Term • ILS investors and issuers like short terms – • the average maturity is between 2 and 3 years. Investors also dislike • long development period. This is a necessary component of • indemnity- based bonds, even PCS. • The longest ILS issued was 10 years. One three year bond took six • years to close – without an ultimate loss. • Dead Capital, frozen collateral. • Notwithstanding, the ILSmarket has been established, • participants behave rationally through the cycle • Maturities are extended in soft markets, shortened in hard ones • Terms and conditions tighten in hard markets , get more relaxed in • soft markets. e.g. more perils added

12. Longevity Risk from an ILS Perspective - Price • ILS investors require a high price to accept a risk, even a • diversifying one • Multiples of expected loss range from 2 to 20 times • Multiples will be higher in hard markets • Are cedant’s prepared to pay?

13. Longevity Risk from an ILS Perspective - Price

14. Longevity Risk from an ILS Perspective - Price

15. Longevity Risk from an ILS Perspective - Price

16. Longevity Risk from an ILS Perspective - Price

17. Longevity Risk from an ILS Perspective - Price

18. Longevity Risk from an ILS Perspective - Price

19. Mortality Bonds Trade with the Market • Absent Financing Rates Cat has Higher Returns • Most Cat bonds are Issued in the BB range • Most Extreme Mortality Bonds issued AA Range • Total Returns for CAT are therefore Double Life Returns • Deduct Financing - the “Insurance” Return is 4 times • Broadly the Bonds move in tandem –whether CAT or Life • Katrina affected Life and ILS – Hard Market • Lehman - both CAT and Life succumbed to Liquidity and CDS • Independent Life Behavior observed with H1N1 concerns

20. END mlane@lanefinancialllc.com mnlane@illinois.edu