Casualty Actuarial Society
“Risk Securitisation 101”
Kymn Astwood, CA
Arrow Reinsurance Company, Limited
(A Goldman Sachs Group Company)
16th October, 2000
23/03/2016 3:36
Agenda
1
Insurance and the Capital Markets are Converging
2
Risk Transfer vs Risk Financing
3
Overview of the Risk-linked Securities Sector
4
Benefits of Risk-linked Securities
5
Structure of Risk-linked Securities
6
Weather Derivatives and Other Alternatives
Insurance and
Capital Markets are
Converging
23/03/2016 3:36
Insurance and Capital Markets are
Converging
Corporations,
Traditional
Insurance and
Reinsurance
Markets
 Pricing and volatility for
insurance and
reinsurance
 1999 – second worst
catastrophe year for the
P&C industry
 Weather hedging driven
by utility deregulation
 Portfolio credit hedging
driven by BIS rules,
cyclical considerations
 Availability of coverage
for high capacity/new
exposures
Capital
Markets
New
Risk
Instruments
Legal and
Regulatory
Infrastructure
 Securities rulings
and opinions
Risk
Assessment
Technology
 Modeling firms
 Standard
documentation
 Academic and
governmentsponsored research
 SVO rating
guidelines
 Internet-based data
accessibility
 Rating agency
expertise
 Concern over
correlation – particularly
in down markets
 Desire for more
concrete risk
assessment
 “Alpha-driven” investing
23/03/2016 3:36
Risk Markets Group
The Goldman Sachs Group, Inc.
Goldman, Sachs & Co.
Investment
Banking
Division
Fixed Income
Currency &
Commodities
RISK MARKETS GROUP
Trading
New York
London
Research
Arrow Re
(a Bermuda
Reinsurer)
GS Risk Advisors
(a Reinsurance
Intermediary)
23/03/2016 3:36
Accessing Multiple Markets for Risk
Management – Past Example
United States Automobile Association (“USAA”)
Capital
Markets
Traditional Reinsurance
Retention
Risk management program shown was designed for an optimal mix of
coverage from reinsurance and capital markets
23/03/2016 3:36
Accessing Multiple Markets for Risk
Management – Past Example
SCOR (a French Reinsurer)
Retrocession
Retention and
Capital Markets
Capital Markets
Retention
Risk management program shown was designed for an optimal mix of
coverage from reinsurance and capital markets
23/03/2016 3:36
Accessing Multiple Markets for Risk
Management – Past Example
XL Mid Ocean Re (a Bermuda Reinsurer)
Capital Markets
Reinsurance
Retention
Risk management program shown was designed for an optimal mix of
coverage from reinsurance and capital markets
23/03/2016 3:36
Accessing Multiple Markets for Risk
Management – Past Example
State Farm Insurance Group (a US Insurer)
Traditional
Reinsurance
Retention by
Arrow Re
Capital
Markets
Retention by State Farm
Retention by State Farm & FHCF
Risk management program shown was designed for an optimal mix of
coverage from reinsurance and capital markets
Risk Management
Alternatives
23/03/2016 3:36
Risk Management Alternatives
Reinsurance
Risk Transfer
Derivatives
Securities
FONDEN
Risk
Intermediary
Banks
Retained Risk
Risk Financing
Finite Reinsurance
Securities
23/03/2016 3:37
Overview of Coverage Types
Types of Coverage
———————Risk Financing Options ——————
Risk Transfer Coverage
 A premium is paid
in advance equaling
the market price of
risk
Pre-Funded Coverage
Post-Funded Coverage
 Premiums paid at
levels exceeding the
market price of risk.
Excess builds up in a
fund which is returned
if there is no loss
 Payout determined
and paid post-event.
It is repaid over time.
There may be a small
option premium paid
in advance
23/03/2016 3:37
9
Impact of Market Forces
Securitization will become increasingly cost competitive with
reinsurance because of the forces driving both the markets
Securitization
Reinsurance
 Hardening of retrocessional markets
 Problems in Australian insurance
market
 Earthquakes in Turkey, Taiwan, Greece,
Mexico
 Hurricanes in U.S. and Central America
 Higher satellite and aviation losses
 Problems with workers compensation
market due to Unicover-managed pool
 Pressure to increase premiums to
restore investor confidence in
insurance/reinsurance stocks
 Industry consolidation
 Stable spreads with
respect to BB
corporate bonds
 Lower transaction
costs
 Increased investor
comfort with the
asset class
Overview of the
Risk-Linked
Securities Sector
23/03/2016 3:37
Overview of Risk-Linked Securities
1996-1997
First Property Risk
Securitisation
1998-1999
Issuance Volume
Grows to over 1bn
Catastrophe per Year
 Securities whose returns are linked
on the occurrence of events
 Ratings based on the probability of
event occurrence
 Credit risk (as opposed to event), is
generally minor
 High grade investment trust
account
 Additional credit support
2000
Issuance Increasing,
Secondary Trade
Volume Tops $1bn
 Most bonds floating rate, 1-5 years
23/03/2016 3:37
Evaluating Risk-Linked Securities
Quantifying Default Risk
Probability in %
100
75
Risk-linked securities
typically transfer risk in
the extreme “tail” of the
probability curve - low
frequency but high
severity
50
25
Shown
on next
page
0
Losses in USD
23/03/2016 3:37
Evaluating Risk-Linked Securities
Typical Structure
Losses ($)
Securitized
Risk Layer
Coinsurance
0.2%
Exhaustion
Point
Expected Loss
Attachment
Point
1.0%
0.2%
1.0%
Retention
Probability
(cumulative)
23/03/2016 3:37
Sectors of the Risk Securitisation
Market
Catastrophe $3,880 MM
Namazu Re 2.8%
Mosaic Re II 1.3%
Parametric Re 2.6%
Mosaic Re 1.3%
Juno Re 2.3%
George Town Re 1.3%
Residential
Re I
11.4%
Gemini Re 4.3%
Concentric Ltd 2.8%
Circle Maihama Ltd 2.8%
Residential Re II
12.8%
Basis Risk Securitization 0.3%
Seismic Re 4.3%
Winterthur 0.2%
Residential Re III 5.7%
SR Earthquake Fund 3.2%
Residential Re Swap 1.0%
Soc Gen 2.8%
Trinity Re 2.0%
SLF I - IV 1.6%
Trinity Re 1999 1.5%
MMC New Madrid Swap 1.4%
Mitsui Risk Transfer Option 0.9%
XL MidOcean Swap 2.8%
Hedge Financial Swap 2.6%
Atlas Re 5.7%
Axa Risk Transfer Option 0.9%
Hannover III 1.4%
Hannover II 2.8%
Hannover I 2.4%
Gold Eagle 5.2%
Pacific Re 2.3%
Domestic Inc. 2.8%
Halyard Re 0.5%
AIG Combined Risk 0.3%
23/03/2016 3:37
Sectors of the Risk Securitisation
Market
Weather Derivatives/ Securitisations $4,550 MM
Weather Derivatives
$4,500M (est.)
Kelvin Ltd
$50M
23/03/2016 3:37
Sectors of the Risk Securitisation
Market
Default $743 MM
Freddie Mac
"MODERNs"
$243M
Gerling "SECTRS"
$500M
23/03/2016 3:37
Sectors of the Risk Securitisation
Market
Hard Asset Value $566 MM
Gramercy Place
(Toyota Motor Credit)
100%
23/03/2016 3:37
Sectors of the Risk Securitisation
Market
Life $855 MM
Hannover I
7%
Hannover II
14%
Hannover III
6%
ASLAC Il-IV
18%
Mutual
Securitisation
p.l.c.
50%
ASLAC l
5%
23/03/2016 3:37
League Table
As of September 2000
Number of
Issues
24
Goldman Sachs
5
Lehman
5
Merrill Lynch
3
SBC Warburg
5
Aon Capital
1
Morgan Stanley
$243
3
Citibank
$253
3
Swiss Re
$232
3
Salomon Smith Barney
$224
1
American Re
$182
$4,113
$1,400
$1,267
$631
$314
0
500
1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500
23/03/2016 3:37
Market Profile of Risk-linked
Securities
RATING
BBB
7.1%
B or
Below
6.3%
Not
Rated
4.3%
AAA-A
24.2%
BB
58.1%
23/03/2016 3:37
Market Profile of Risk-linked
Securities
RISK
US Earthquake
9%
Japan
Earthquake
10%
Insolvency
13%
Japan
Typhoon
1.8%
Tem perature
1%
US Hurricane
29%
Auto
Lease
Residual
17.9%
Portfolio
of
Risk
17.9%
23/03/2016 3:37
Market Profile of Risk-linked
Securities
TERM
5 plus
years
2.3%
3 to 5
years
8.6%
1 to 3
years
88.1%
23/03/2016 3:37
Current Investor Profile
Catastrophe Transactions
Total (Risk Capital) Distribution
Geographic Sector by Sales Office
Chicago 8.5%
Life
Insurers
16.6%
Non-Life
Insurers
3.9%
Boston 2.9%
Mutual Fund/
Investment
Advisor 28.9%
San Francisco
23.8%
Banks
8.2%
Reinsurers/
Intermediaries
21.0%
Proprietary/
Hedge Funds
21.9%
New York
51.0%
118 Institutional Investors
London 5.2%
Frankfurt 3.4%
Milan 0.2%
Paris 1.0%
Toronto 2.7%
Vancouver 0.2%
Tokyo 1.6%
Benefits of
Risk-Linked
Securities
23/03/2016 3:37
Benefits of Risk Securitization
Issuer Perspective
 Diversification of sources of risk protection
 Additional capacity for certain risks / geographic areas
 No credit risk due to full-collateralization of securities
 Prompt claims payment following a loss event
 Clearly defined trigger reduces disputes regarding
covered claims
 Multi-year coverage at a fixed cost may be locked in at
inception
 Market perception as an innovator and industry leader
23/03/2016 3:37
Benefits of Risk Securitization
Investor Perspective
 Uncorrelated Diversification can be achieved due to low
correlation with equity and fixed income investments
23/03/2016 3:37
Risk-Linked Securities
Pricing and Market Spreads
3Q1998
2,000
5/7/1998
Argentina
30/9/1998
(3,500-5,900+)
Brazil
Mexico
1,800
Russia
Venezuela
BB Catastrophe
1,600
BB Corporates
BB Hard Asset Value
Mosaic Re Class A
440
Spread over LIBOR (bp)
1,400
Pacific Re
370
1,200
Residential
Re II
400
1,000
800
Residential Re
576
SR Earthquake Fund
475
Parametric Re
430
Trinity Re
367
HF Re
375
Mosaic Re II
400 Domestic Inc
(Ba2/BB+)
369
600
Gold Eagle
540
Juno Re
420
400
Namazu Re
450
200
Gramercy Place
Class C-1
325
XL Mid
Ocean Re
Tranche A
412
Trinity Re
1999
417
0
02/06/1997
13/08/1997
27/10/1997
12/01/1998
26/03/1998
09/06/1998
20/08/1998
02/11/1998
19/01/1999
Concentric Ltd
(BB+)
310
01/04/1999
15/06/1999
Residential Re III
366
26/08/1999
09/11/1999
23/03/2016 3:37
Risk-Linked Securities
Non-Correlation and Outperformance in Turbulent Markets
Returns: 1998 Third Quarter (%)
S&P 500
(11.5)
Nasdaq Composite
(11.5)
Small Cap Stocks (Russell 2000)
(20.9)
European Equities
(20.7)
Japanese Equities (Nikkei 225)
(18.1)
Emerging Market Debt (10-Year+)
(11.4)
BB Composite
(1.7)
Real estate (Wilshire REIT Index)
(0.9)
1.5
3-Month UST
2.7
GS Cat Bond Basket (a)
5-Year UST
(25)
(a)
6.5
(20)
(15)
(10)
Trinity Re, Residential Re, Mosaic Re, Pacific Re, Parametric Re
(5)
0
5
10
23/03/2016 3:37
Risk-Linked Securities
Non-Correlation and Outperformance in Turbulent Markets
Returns: 1999 Third Quarter (%)
Japanese Equities (Nikkei 225)
(1.4)
Real estate (Wilshire REIT Index)
(9.9)
S&P 500
(7.1)
Small Cap Stocks (Russell 2000)
(6.0)
European Equities (BE500)
(4.3)
BB Composite
(1.9)
1.2
3-Month UST
1.5
5-Year UST
3.2
GS Cat Bond Basket (a)
3.2
Emerging Market Debt (10-Year+)
4.1
Nasdaq Composite
(25)
(a)
(20)
(15)
(10)
Trinity Re, Residential Re, Mosaic Re, Pacific Re, Parametric Re
(5)
0
5
10
23/03/2016 3:37
Benefits of Risk Securitization
Investor Perspective
 Uncorrelated Diversification can be achieved due to low
correlation with equity and fixed income investments
 Attractive Risk/Return Profile compared with similarly
rated corporate bonds
23/03/2016 3:37
RLS Offer Higher Returns Than
Similarly-Rated Securities
Summary of Risk-Linked Securitisation Transactions
14







Spread to LIBOR (%)
12
10
8
Portfolio of Risk
US Hurricane
US Quake and Wind
Japanese Earthquake
US Quake
Typhoon
Weather
Russia
Efficient Frontier
Expansion
6
B-Corporate
Brazil
4
2
BB-Corporate
Mexico
0
0
0.5
1
1.5
2
2.5
Expected Loss (%)
3
3.5
4
4.5
5
23/03/2016 3:37
Benefits of Risk Securitization
Investor Perspective
 Uncorrelated Diversification can be achieved due to low
correlation with equity and fixed income investments
 Attractive Risk/Return Profile compared with similarly
rated corporate bonds
 Sophisticated Risk Analysis is performed by independent
catastrophe-modeling firms
23/03/2016 3:37
The Role of the Expert Modeling Firm
Providing a Level Playing Field for Investors
Rating Agencies
Objective 3rd-party
quantification
Proven catastrophe
modeling
technology
Expertisation
of Analysis
Multi-dimensional
technical support
Education for all
constituents
Due diligence
No “black box”
models
23/03/2016 3:37
Benefits of Risk Securitization
Investor Perspective
 Uncorrelated Diversification can be achieved due to low
correlation with equity and fixed income investments
 Attractive Risk/Return Profile compared with similarly
rated corporate bonds
 Sophisticated Risk Analysis is performed by independent
catastrophe-modeling firms
 Liquidity is provided by the growing secondary market
trading of risk-linked securities
23/03/2016 3:37
RLS – Market Liquidity
Secondary Trading Volume
Goldman Sachs’ Secondary Trading Volume
84.9
Aggregate Volume ($millions)
80.0
67.1
47.5
37.3
26.3
17.0
15.6
7.0
6.0
Ju
n
19
b
Fe
19
9.3
2.5
00
99
99
98
19
99
1.3
1.0
O
ct
Ju
n
19
b
Fe
19
98
97
19
98
2.5 4.0 3.3
1.5
O
ct
n
19
97
4.0
13.0
20
9.5
8.2
Ju
23.4
18.5
b
23.2
Fe
29.0
37.0
19
35.5
O
ct
37.0
23/03/2016 3:37
Hurricane Bonds Trade Actively
Through Storm Events
Storm Category
Tropical Depression
Tropical Storm
1 (74-95 mph)
2 (96-110 mph)
3 (111-130 mph)
4 (131-155 mph)
5 (>155 mph)
Hurricane Floyd:
Residential Re
Prices
Basic Structure of
Risk-Linked
Securities
23/03/2016 3:37
Risk Securitisation
Basic Structure
Transaction:
(risk capital of €500 million)
Premium
Insurer
Reinsurance
Contract
Issuing
Vehicle
€500
Investors
LIBOR +
Premium
Potential Outcomes:
Event Happens
Insurer
Up to
€500
Event Doesn’t Happen
Issuing
Vehicle
Up to
€500
Investors
Case Study
Alpha Wind 2000-A Ltd.
Hurricane Risk Securitization
(State Farm Insurance Group)
23/03/2016 3:37
Summary Structure
At Issuance
State Farm
Reinsurance
Premium
Contract
Premium
Proceeds
Alpha Wind
18 Investors
A Bermuda SPV
Arrow Re
Retro
Contract
Notes $52.5 m
Equity $37.5 m
Trust
Securities
Case Study
Concentric / Circle Maihama
Earthquake Risk Securitization
(Oriental Land Co. Ltd.)
Concentric, Ltd.
Floating Rate
Principal-at-Risk Notes
Circle
Maihama, Ltd.
Floating Rate Extendible Notes
(FRENs)
April 1999
23/03/2016 3:37
Case Study: Circle and Concentric
 To provide Oriental Land Co., Ltd., owner and
operator of Tokyo Disneyland®, with:
Purpose
 Fully collateralised multi-year risk transfer
earthquake protection
 Fully collateralised post-earthquake stand-by
financing facility
 First direct access of capital markets by corporate
for catastrophe risk transfer
Highlights
 First catastrophe contingent financing facility in
Japan
 Parametric triggers
23/03/2016 3:37
Case Study: Circle and Concentric
Summary of Terms
Concentric, Ltd.
Size
Use of
Proceeds
Term
Circle Maihama, Ltd.
 US $100 million
 US $100 million
 Invested in AAA/Aaa
rated Directed
Investments to
collateralised Financial
Contract
 Initially: Invested in
AAA/Aaa rated Directed
Investments
 After event: Purchase
Bonds issued by Oriental
Land
 Scheduled May 2004 (if no
Trigger Event Earthquake)
 5 years (due May 2004)
Coupon
 US$ LIBOR + 310bps
 US$ LIBOR + 75bps
Ratings
 BB+/Ba1/BB+
 A/A
Payout
Structure
 Principal Reduction at
Various Magnitudes
23/03/2016 3:37
Case Study: Circle and Concentric
Underlying Earthquake Exposure
Inner Circle
Outer Ring
Radii
Inner Circle: 10 km
Inner Ring: 50 km
Outer Ring: 75 km
Central Point
Coordinates
o
Longitude: 139 53’ 03’’E
o
Latitude:
35 37’ 47’’N
Narita
Tokyo
Yokohama
Maihama and
Tokyo Disneyland
Chiba
Boso Peninsula
Trigger Structure
Epicentre of Earthquake must be located within
inner circle, inner ring or outer ring
Frequency of Trigger
Inner Ring
Izu Peninsula
Pacific
Ocean
62.4bps
85%
40%
25% 32.5%
70% 77.5%
62.5%
62.5%
50%
47.5% 55%
37.5%
25%
6.7
6.9
75%
Inner Ring
Inner Circle
6.5
92.5% 100%
7.1
7.3
7.5
Japan Meteorological Agency
Magnitude
100%
87.5% 50%
25%
100%
75%
Outer Ring
7.7
7.9
Weather Risk
Hedging
23/03/2016 3:37
Weather Risk Management
 First weather derivative traded in 1996
 $5 billion of weather derivatives executed to
date
 Estimated market growth $70 to $100 billion
 Estimated that $1 trillion of $7 trillion U.S.
economy subject to weather risk
23/03/2016 3:37
Impact of Weather on Business
Utilities
Municipalities
Weather
Volumetri
c
Exposure
s
Energy
Industry
Resorts
Beverage
Producers
Agricultural
Industry
23/03/2016 3:37
Impact of Active Risk Management
Investment Research on Peoples Energy Corp.
“Strong FY1Q
despite warm
weather … $0.05
positive EPS impact
of weather
insurance … We
continue to rate
PGL shares Market
Outperformer”
“We are initiating
coverage of
Peoples Energy
with a Market
Performer Rating”
9/14/1999
10/28/1999
“We are raising our rating on PGL to Market
Outperformer … Peoples recently
announced it purchased a weather
insurance policy that would limit the
company’s annual EPS risk from warmer
than normal weather to about $0.25 …
while retaining all of the upside”
1/20/2000
“Strong FY2Q despite warm
weather because of weather
insurance … This weather
insurance to date has already paid
significant dividends – earnings
would have been hurt an additional
$0.17 year to date if no weather
insurance had been purchased …
Market Outperformer”
2/15/2000
4/24/2000
“Reducing FY00 estimates due to
weather … Although weather has once
again proved disappointing, we
continue to view the purchase of
insurance favorably because it does
limit the downside risk … Maintain
Market Outperformer Rating”
23/03/2016 3:37
Weather Risk
Hydro Power
Historical Hydro Dam Filling Levels in Norway
Hydropower Electricity Generation in Norway
Probability Distribution of Annual Rainfall
Securitisation
ofof
Securitisation
Extreme
Drought
Extreme
Drought
Risk
Risk
Traditional Insurance
Cover for Moderate
Drought Risk
Drought
Mean Annual
Rainfall
Case Study
Kelvin Ltd.
Weather Risk Securitization
(Koch Energy Trading, Inc.)
23/03/2016 3:37
Case Study: Kelvin, Ltd
Weather Risk Securitization
Sponsor
 Koch Energy and Trading, Inc, a subsidiary of Koch
Industries, Inc.
 One of the largest privately held corporations in the
United States
 Based in Wichita, Kansas with more than 16,000
employees worldwide
 A diversified company involved in oil and gas, chemicals,
plastics, energy services, chemical and environmental
technology products, asphalt products, metal and mineral
services, agriculture and financial services
 To manage weather risk embedded in Koch’s energy and
agricultural businesses
Purpose
 To create capacity in order to offer customer solutions
 To broaden investor participation in the weather market
23/03/2016 3:37
Case Study: Kelvin, Ltd
Weather Risk Securitization
Defined Portfolio Notional Amount and Risks
$140MM Warm Winter Swaps
Milwaukee
Sioux Falls 40
$94MM Cold Winter Swaps
Sault
Chicago Ste. Marie
35 10
Covington
10 4
Oklahoma CityIndianapolis
10
New York
25
25 25 25
Columbus Baltimore
Investor risk is cold winter
Investor risk is warm winter
$66.5MM Cool Summer Swaps
$41MM Other Contracts
Sault Ste. Marie
Bismarck 3
Portland
3.5
4
Sioux Falls
15 10
2
Green Bay
3.5
San Francisco Covington 3.5 Cleveland
2
Charlotte
Oklahoma
15
15
City
15
Birmingham
4 San Francisco
Philadelphia
5
2
Columbus
3
Oklahoma City
2
Investor risk is hot summer
Tampa
Investor risk is cool summer, warm
winter and cold winter (freeze)
23/03/2016 3:37
Case Study: Kelvin, Ltd
Weather Risk Securitization
Summary of Terms
Kelvin, Ltd. First Event Senior Notes
Issuer
Kelvin, Ltd
Description
First Event Weather-Linked
Fixed Rate Senior Notes
Risk Capital
$22 million
Maturity
February 14, 2003
Coupon
15.80% (at risk)
Ratings
B- (DCR)
Annual
Probability
of:
Annual
Expected
Reduction
Coupon Reduction:12.1%
First Dollar:
9.2%
Full Reduction:
0.5%
4.45%
Kelvin, Ltd. Second Event Senior Notes
Issuer
Kelvin, Ltd
Description
Second Event Weather-Linked
Fixed Rate Senior Notes
Risk Capital
$23 million
Maturity
February 14, 2003
Coupon
8.70% (at risk)
Ratings
BBB-/BB+/BB (DCR/Fitch/S&P)
3 Year
Expected
Reduction
0.60%
23/03/2016 3:37
Derivative Transactions
Accessing Reinsurance from Investors -- Selected Examples
 State Farm/Tokio Marine Swaps (April 2000)
 Traded $200m of Japanese earthquake exposure for Midwest
earthquake directly
 Oriental Land Currency Swaps (May 1999)
 Ability to pay premium and receive compensation in Japanese
yen for a $USD risk-linked security
 CAT Ltd. Hurricane Swap (July 1997)
 $35m of East Coast U.S. wind coverage linked to terms of
Residential Re securities
Derivative transactions offer the ease of execution of
reinsurance, and permit investors in the capital markets
to supplement a reinsurance program
For additional
information regarding
this presentation, please
contact:
Kymn Astwood
441 296 8107
kymn.astwood@gs.com
Arrow Reinsurance Company, Limited
(A Goldman Sachs Group Company)
16th October, 2000