Personal Auto Securitization
Northwest Actuarial Forum
Parr Schoolman, FCAS, MAAA
Vice President & Actuary Aon Re Services
September 5, 2008
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Agenda Slide
Section 1
Securitization History
Section 2
Personal Auto Securitization
Section 3
Personal Auto Securitization Example - Axa Sparc2
Section 4
Conclusion
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Section 1: Securitization History
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Securitization History
US Government Sponsored Entities
 1938 US Congress established The Federal National Mortgage Association (“Fannie
Mae”, or FNMA)
• Original mandate was to buy Federal Housing Administration and Veterans
Administration loans from lenders.
 1968 US Congress divides Fannie Mae into two organizations:
• FNMA – Privatized with a mandate to establish a secondary market of
conventional mortgages
• Government National Mortgage Association (“Ginnie Mae” or GNMA) - remained
a government entity within the Department of Housing and Urban Development,
and used to finance government assisted housing programs
 1970 The Federal Home Loan Mortgage Corporation (“Freddie Mac”, or FHLMC) was
established as a government-chartered corporation owned by 12 Federal Home Loan
banks.
• Eventually privatized in 1989
 Though privatized, Fannie Mae and Freddie Mac can borrow directly from the US
Treasury.
Source: The Handbook of Fixed Income Securities, Fabozzi, Frank J., 6thEdition, 2001
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Securitization History
Mortgage Backed Securities
 Asset securitization started with Mortgage Backed Securities associated with these
GSE’s
• 1970 GNMA issued the first Mortgage Backed Securitization
• Freddie Mac followed in 1971, Fannie Mae in 1981
 GSE’s pooled the mortgages they had purchased, and created securities with the
resulting mortgage payment cashflows on these pools
• GSE’s guaranteed interest and principle payments on these securities
– GNMA securities had the explicit guarantee of the US government
– Securities issued by Fannie, Freddie where guaranteed by the GSE.
• Payments to bond holders on a monthly basis, including both interest and
principle payments
 Securities were pure pass-throughs, with principle and interest payments of the pooled
mortgages shared proportionally by all notes
• Like quota share and pooling agreements for insurance
Source: The Handbook of Fixed Income Securities, Fabozzi, Frank J., 6th Edition, McGraw-Hill 2001
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Securitization History
CMO Innovation
 1983 Freddie Mac and Salomon Brothers created the first multi-class mortgage
security – the Collateralized Mortgage Obligation.
 Created Three Tranches – Short, Intermediate, and Long term obligations
• Short – Received first principle payments
• Intermediate – Received principle payments after Short notes were redeemed
• Long – Last to received principle payments
30 YEAR MORTGAGE PRINCIPLE PAYMENT SCHEDULE
1
25
49
73
97
121
145
169
193
217
30 YEAR MORTGAGE POOL PREDICTED PRINCIPLE SCHEDULE
241
265
289
313
337
1
25
49
73
Month
121
145
169
193
Month
Source:
1. A Primer on Securitization, Kendall, Leon T., Fishman, Michael J. MIT Press, 2000
2. The Handbook of Fixed Income Securities, Fabozzi, Frank J., 6th Edition, McGraw-Hill 2001
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5
217
241
265
289
313
337
Securitization History
Other Asset Backed Security Innovations
• First ABS Transaction – 1985, Sperry Corporation sold notes backed by computer
leases
• Auto Loans – First transaction in 1986, GMAC raised $4B in notes backed by
automobile loans
• Other Asset Classes:
– Credit Card Receivables
– Student Loans
– Home Equity Loans
• Other innovations
– CDO: Securitization of pools of loans/notes/MBS/ABS
– CDO2: Securitization of pools of CDO’s
Source:
1.
Cowan, Cameron, L – Testimony before the United States Howes of Representatives Subcommittee on
Housing and Community Opportunity Subcomittee on Financial Institutions and Consumer Credit, November 5,
2003
2.
Source: A Primer on Securitization, Kendall, Leon T., Fishman, Michael J. MIT Press, 2000
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Securitization Structuring
 Structured Finance Securitizations are very similar to the concept of insurance
• Credit losses on pooled assets/receivables/cashflows are more predictable than
when they are held separately – Law of Large Numbers
• Re-structuring cashflows of pooled assets allows for the creation of debt
securities that have tranches with a lower probability of default than achievable if
each asset evaluated separately
Tranche I
Tranche II
Tranche III
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Securitization – Basic Structure
Future Cashflows
Proceeds
Sponsor
Company
Asset
Pool
Priciple &
Interestt
Debt
Senior Debt
Tranches
Special
Purpose
Vehicle
Debt
Investors
Debt
(SPV)
Proceeds less Fees
Proceeds
Proceeds
Jr Debt
Tranche
Shares
Proceeds
Preferred
Shares
Priciple &
Interestt
Proceeds
Residual
Cashflow
Proceeds
Fees
Collateral
Manager
Trustee
 Sponsor company exchanges asset pool for cash.
 Collateral Manager purchases and manages assets in accordance with set guidelines.
 Trustee ensures compliance with guidelines and structure features.
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Equity Investors,
Sponsor Co
Securitization Benefits
Borrower
Sponsor/Originator
Investor
More consistent funding
availability
Ability to convert assets into cash
Increased supply of “investment
grade” debt
Increased borrowing options
regarding duration and debt
covenants
Profits on sale, with increased
servicing income
More investment options regarding
duration and credit quality
Cheaper source of capital for
non-financial institutions
compared to general debt
issuance
More efficient use of capital
Enhanced diversification and
liquidity
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Section 2: Personal Auto Securitization
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Personal Auto Securitization
Proposed Structure
Reinsurance
Agreement
Debt
Ceded Premium
Sponsor
Company
Sliding Scale Ceding
Commission, Loss
Payments
Special
Purpose
Reinsurance
Vehicle
Senior
Senior Debt
Tranches
Cash
Debt
Investors
Junior
Debt
Jr Debt
Tranche
Cash
Debt
Investors
 A Special Purpose Reinsurer is created to issue debt, and provide reinsurance to
sponsor insurance company.
 Reinsurer issued debt is linked to the loss experience of the reinsurance agreement
• Debt will default if losses exceed threshold
• Otherwise, premium will be used to pay off debt and interest
 Allows debt as part of the required capital to support the personal auto premium,
reducing the ultimate cost of capital
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Personal Auto Securitization
Tranches
 Debt acts as a collateralized aggregate
stop loss reinsurance cover
• If Loss Ratio > Tranche Attachment
Loss Ratio, principle becomes at risk
Equity Tranche
• If Loss Ratio < Tranche Attachment
Loss Ratio, principle repaid to debt
investor
Jr Tranche
Sr Tranche
 The closer the debt attachment loss
ratio to the expected loss ratio, the
longer the time required to settle.
• Jr Tranche typically covers a single
accident year
Expected
Loss Ratio
Spread above
ELR
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• Sr Tranche can be a multi-year cover
Debt Trigger
Loss Ratio
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Section 3: Personal Auto Securitization
Example - Axa Sparc2
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Axa: SPARC2 Transaction
4 Reinsurance
Agreements
Axa
Belgium
Axa
Germany
Senior Debt
Tranches
Nexgen Re
Senior
Debt
Cash
Institutional
Investors
Junior
Jr Debt
Tranche
Axa Italy
Axa Spain
Debt
Cash
Institutional
Investors
 Transaction completed June 2007
Guaranty by Axa
of each insurer‘s
obligations under
Reinsurance
Agreements
 Axa’s second auto (Motor liability) securitization
transaction
• Securitized French motor liability in 2006
Axa
• This transaction securitized a motor
liability portfolio of country specific
subsidaries
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Axa: SPARC2 Transaction
Debt Tranches
Loss Ratio:
69.0%
72.5%
74.3%
78.9%
89.0%
93.2%
Class C
noasfasdfasf
Equity
Tranche
Class D
notes
Class C
notes
Class B
notes
Class A
notes
Rating (S&P/Fitch)
Retained
by Axa
BB/BB-
BBB-/BBB
A/A+
AAA/AAA
Amount
39.2M
Eur
100.1M
Eur
220.0M
Eur
91.5M
Eur
Loss Ratio Spread
+3.5%
+5.3%
+9.9%
+20%
 Class D – Junior Debt Tranche covering a single accident year
 Class A, B, C – Senior Debt Tranches covering multiple accident years
 Equity Tranche – Retained by Axa
 Debt Tranches are the equivalent of an aggregate stop loss reinsurance cover, providing
20.7% loss ratio points of coverage excess a loss ratio of 72.5%.
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Axa: SPARC2 Transaction
Quota Share Agreements
4 Reinsurance
Agreements
 4 country specific subsidiaries entered into QS
reinsurance agreements with Nexgen Re
Axa
Belgium
 Each subsidiary required to retain 15% of cession
Axa
Germany
Nexgen Re
 Reinsurance treaties will cover claims arising from
motor insurance for a period of 1 year only
Axa Italy
 Insurers pay premium to Nexgen Re, recieve back a
fixed commission and proportional losses of the pool
Axa Spain
 Individual claim severities capped (varies by country)
Guaranty by Axa
of each insurer‘s
obligations under
Reinsurance
Agreements
Axa
 Minimum average premium per policy guarantee
provided by insurers
 For each year, the sum of each insurer’s planned loss
ratio is used to determine the Global Loss Ratio
• 69.0% for 2007
 Axa guarantees each insurer subsidiary’s obligations
under the reinsurance agreements
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Axa: SPARC2 Transaction
Senior Debt Tranches
Senior Debt Tranches
Senior Debt
Tranches
Senior
Nexgen Re
 Maturity date July 2013, with an expected maturity
date of July 2011
Debt
Cash
Institutional
Investors
Junior
Jr Debt
Tranche
Loss Ratio:
69.0%
72.5%
74.3%
Debt
78.9%
Class C
noasfasdfasf
Equity
Tranche
Class D
notes
Class C
notes
Rating (S&P/Fitch)
Retained
by Axa
BB/BB-
Amount
Loss Ratio Spread
Institutional
Investors
Cash
89.0%
93.2%
Class B
notes
Class A
notes
BBB-/BBB
A/A+
AAA/AAA
39.2M
Eur
100.1M
Eur
220.0M
Eur
91.5M
Eur
+3.5%
+5.3%
+9.9%
+20%
 Three Tranches, with separate debt ratings
 Covers multiple accident years (although only 1 at a
time)
• If ultimate loss ratio is determined to be less than the
senior note trigger, the notes are to roll over to cover the
next accident year
• At the end of each annual cover period, reinsurance
treaty may be renewed subject to rating agency
affirmation, and that no loss ratio trigger or termination
event has occurred
 If loss ratio exceeds the trigger an appraisal procedure
is triggered
• Auditor review of premium and loss files (open and
closed claims)
• Actuarial review
• Process could take up to 2 years
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Axa: SPARC2 Transaction
Junior Tranche
Junior Debt Tranche
Senior Debt
Tranches
Senior
Nexgen Re
Debt
Cash
Institutional
Investors
 Attaches 3.5% loss ratio points above Global Plan
Loss Ratio of 69.0%
Junior
Jr Debt
Tranche
Loss Ratio:
69.0%
72.5%
74.3%
Class C
noasfasdfasf
Equity
Tranche
Class D
notes
Class C
notes
Rating (S&P/Fitch)
Retained
by Axa
BB/BB-
Amount
Loss Ratio Spread
Debt
Institutional
Investors
Cash
78.9%
 Maturity date July 2010, with an expected maturity
date of July 2008
89.0%
93.2%
Class B
notes
Class A
notes
BBB-/BBB
A/A+
AAA/AAA
39.2M
Eur
100.1M
Eur
220.0M
Eur
91.5M
Eur
+3.5%
+5.3%
+9.9%
+20%
 Covers a single accident year
• Implication is that a separate Junior Tranche would be
created for each new accident year
 If ultimate loss ratio is determined to be less than
72.5%, the notes expected to be redeemed
 If loss ratio is above 72.5% an appraisal procedure is
triggered
• Auditor review of premium and loss files (open and
closed claims)
• Actuarial review
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Axa: SPARC2 Transaction Benefits
Axa Press Release June 4, 2007
This transaction also confirms that insurance-linked securities (ILS) are an effective alternative to
the reinsurance market, even for diversified liabilities, while eliminating counterparty risk. In
addition the growing ability to transfer risks to the financial markets should contribute to put the
insurance industry on a level playing field with banks
“This new transaction further demonstrates AXA’s permanent search for innovation, which is a key
driver of our Ambition 2012 program,” said Denis Duverne, AXA’s chief financial officer and member
of the management board. “Through this pan-European securitization, AXA intends to crystallize
the economic benefits of mutualisation and diversification and to anticipate the expected evolution
of the regulatory environment (Solvency II), which will take into account the retained risks.”
“We are confident that the market for ILS will continue to develop, as they are an efficient risk and
capital management tool for the insurance industry, as well as a new attractive asset class for
investors.”
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Section 4: Conclusion
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Personal Auto Liability Securitization
Potential Benefits, Challenges
Benefits
Challenges
Alternative capital source for insurers
Regulatory and rating agency treatment
Allows for the creation of a more efficient capital
structure for low volatility lines of business
Accounting & Tax treatment
Fully collateralized, eliminating counterparty risk
associated with traditional reinsurance
Sponsor Company Demand
Strong capitalization reduces need for capital raising
Strong Debt Rating
Reversed cashflows compared to MBS, ABS transactions (securitizing
cashflows around a liability, rather than an asset)
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