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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Disclaimer:
This presentation has been prepared by American Re Securities Corporation on behalf of 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).
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Agenda
– Disclaimer
– Transaction Structures
– Comparison of Structures, Costs, and Timing
– Recent Developments in the Securitization Markets
– Summary
4
Fundamental Transaction Structure
Investors
Optional
Premium
Sponsor
Contingent
Claims
Payment
American
ReInsurance
Coupon
and
Principal
Premium
Contingent
Claims
Payment
Principal
Special
Purpose
Corporation
Principal
Interest and
remaining
principal at
maturity
Collateral
Trust
– 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
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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:
Maximum Possible
Exposure
Indemnity
Cat Bond
Traditional
(Re)insurance
Retention
Sponsor
Investors
and Insurer
Re-Insurers
and Sponsor
Sponsor
– Investors have extension risk
– No recovery for Sponsor until the end of the
development period
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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
Maximum Possible
Exposure
Sponsor
Parametric
Cat Bond
Investors
Traditional
(Re)insurance
Re-Insurers
and Sponsor
– No extension risk for Investors
– Less elapsed time before Sponsor’s recovery
than for an indemnity bond
Retention
Sponsor
– Treated by the sponsor as a financial
contract rather than insurance - subject to
derivative accounting under FAS 133
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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
ModILSSM
Cat Bond
Traditional
(Re)insurance
Retention
Sponsor
Investors
Re-Insurers
and Sponsor
Sponsor
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Agenda
– Disclaimer
– Transaction Structures
– Comparison of Structures, Costs, and Timing
– Recent Developments in the Securitization Markets
– Summary
9
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
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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
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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
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Who Buys CAT Bonds?
Mutual Funds
Life Insurers
Hedge Funds
Reinsurers
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
Banks
Non-Life Insurers
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What are the costs of a securitization?
–
–
Initial transaction costs
are constant for any
transaction of $100
million in size or less:
Estimated One-Time Transaction Costs
Legal Costs
Modeling Costs
Structuring and Underwriting Fee
Rating Agencies
Printing Costs
Miscellaneous and Accounting
Trustee Fee
Total One-Time Transaction Costs
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:
$350,000
$200,000
$1,500,000
$200,000
$20,000
$25,000
$30,000
$2,325,000
1 Year
3 Year
5 Year
500 bps
525 bps
550 bps
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What are the costs of a securitization?
–
All-in, estimated transaction costs, expressed as an annual Rate-on-Line:
$200 Million
$100 Million
$50 Million
1 Year
6.2%
7.3%
9.7%
3 Year
6.1%
6.0%
6.8%
5 Year
5.7%
6.0%
6.4%
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What is the implementation time frame?
Structural Design
Risk Modeling
Indemnity Bond
Documentation
ModILS SM or
Parametric Bond
Rating Agency
Marketing
Closing
0
1
2
3
4
5
6
7
Elapsed Time (in months)
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Agenda
– Disclaimer
– Transaction Structures
– Comparison of Structures, Costs, and Timing
– Recent Developments in the Securitization Markets
– Summary
17
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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
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Several new participants have approached
the capital markets:
–State Farm
–SCOR
–Munich Re
–Lehman Re
–Vesta Insurance Group
–AGF
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Issuance Volume
– 1999 Transactions include:
–
–
–
–
–
–
–
–
–
–
Issuer
Domestic Inc.
Concentric, Ltd.
Circle Maihama
Halyard Re
Residential Re
Juno Re, Ltd.
Mosaic Re II
Gold Eagle Capital
Namazu Re
– TOTAL
Bond Size
$100
$100
$100
$17
$200
$80
$45.7
$182.1
$100
Sponsor
Kemper
Tokyo Disneyland
Tokyo Disneyland
Sorema
USAA
GKG
F&G Re
American Re
GKG
$924.8
Peril
Estimated Annual Premium*
New Madrid EQ
$4.6 million
Tokyo EQ
$3.5 million
Tokyo EQ
$1.2 million
European Wind
$1.8 million
U.S. Windstorm
$8.5 million
U.S. Windstorm
$4 million
Diverse U.S.
$3.6 million
Diverse U.S.
$12 million
Japanese EQ
$7.2 million
$46.4
– 2000 Transactions include:
–
–
–
–
–
–
–
–
–
–
Issuer
Atlas Re
Seismic, Ltd.
Halyard Re (Remarketing)
Alpha Wind
Residential Re
NeHi
Mediterranean Re
PRIME Capital Hurricane
PRIME Capital CalQuake & Eurowind
– TOTAL
Bond Size
$200
$150
$17
$89.5
$200
$50
$129
$168
$138
$1,141.5
Sponsor
SCOR
Lehman Re
Sorema
Arrow Re/State Farm
USAA
Vesta
AGF
Munich Re
Munich Re
Peril
Estimated Annual Premium*
Diverse Worldwide
$24 million
California EQ
$10.5 million
European Wind
$1.5 million
U.S. Windstorm
$6.8 million
U.S. Windstorm
$10 million
U.S. Windstorm
$2.6 million
Eurowind & Monoco EQ
$9 million
U.S. Windstorm
$14.5 million
Eurowind & Calif. EQ
$14 million
$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.
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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 risklinked securities, with a particular emphasis on educating investors.
This is scheduled to take place March 21 to 23 in Miami, Florida.
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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 offshore 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
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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.
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