“How does the Insurance Securities (ILS) Market digest the current Demand?”
Presentation to the CFA Society Switzerland
22nd October 2013
For professional/qualified investors use only, 22nd October 2013
Contents
ILS Market Overview
Recent observations
ILS investing, underwriting (information asymmetry)
Market outlook
Conclusions
2
ILS Market Overview
Terminology
Term
Explanation
ILS
Insurance linked securities, refers to tradable (cat bonds) and less tradable (collateralized
reinsurance) investments. In the latter case, preferred shares of the cell company are the
securities (private ILS)
Broker
«Reinsurance broker», an intermediary between insurance and reinsurance or reinsurance and
retrocessionaire; i.e. not an execution broker
Limit, line, capacity
Premium
The dollar amount «traded» between counterparties, i.e. the protection sold/purchased (principal)
The
dollar
amount
owed
to
the
Not a delta to a reference rate (e.g. CAPM)
protection
seller
for
the
capacity.
Rate on Line (ROL)
Premium expressed in relation to the limit, first indication of return on investment (excluding time
value of money or cash flow considerations)
Private ILS
ILS Transactions which are agreed between two parties. Fully collateralized, investor owns shares
of a protected cell company or notes of a private cat bond
IBNR
Incurred but not reported; an estimate of the liability for claim-generating events that have taken
place but have not yet been reported to the insurer. The sum of IBNR losses plus incurred losses
provides an estimate of the total eventual liabilities for losses during a given period
ILW
Industry loss warranty, a transaction type which uses as trigger mechanism any industry wide loss
information. The protection buyer incurs basis risk as the payout of the transaction is not directly
linked to its suffered loss. Examples are PCS or PERILS as trigger agents
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ILS Market Overview
Insurance Market Overview
Retrocession
Private ILS
Reinsurance
Private ILS
Cat Bonds
Primary
Insurance
Cat Bonds
Broker
Broker
Policyholders:
(home insurance)
Risk is ceded upwards
4
Source: Twelve Capital. As on 30th September 2013.
ILS Market Overview
ILS Market Size
•
•
•
•
•
•
The worldwide market for catastrophe
reinsurance
(the
most
lucrative
reinsurance business) is some USD
250bn in size (pizza)
The largest chunk is still traditional
reinsurance (i.e. not collateralized),
selling capacity on a credit rating
Catastrophe limits worldwide: USD 250 billion
26
18
The convergence market; cat bonds
and collateralized reinsurance, is rapidly
growing now (pizza slice)
Since January 2012 some USD 5 to 6bn
in new capital has entered the cat bond
market, USD 3bn of which in the last 6
months only
Traditional reinsurance
Cat bonds
Collateralized Reinsurance
206
Sourcing cat bonds in the secondary
market can mean entering a winners
curse race
 is the pizza slice growing only or
is the pizza getting larger, too?
Source: Guy Carpenter, Twelve Capital. As on 31st August 2013.
5
ILS Market Overview
ILS Market size: Cat Bonds Issue Volume
Outstanding Cat Bond Volume, 2003-2013
20,000
17,513
18,000
16,155
14,923
16,000
USD million
13,249
12,911
14,000
13,167
11,504
12,000
10,000
8,000
6,608
6,000
4,000
3,005
3,876
4,741
2,000
0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
YTD 2013
Source: Swiss Re Capital Markets. As of 9th July 2013.
Cat Bonds versus US Wind Bonds Volume since 2007
21
12%
18
10%
USD billion
15
8%
12
6%
9
4%
6
2%
3
0%
Jan '07 Jul '07 Jan '08 Jul '08 Jan '09 Jul '09 Jan '10 Jul '10 Jan '11 Jul '11 Jan '12 Jul '12 Jan'13 Jul'13
Other perils
US wind bonds
Coupon of all cat bonds
Coupon of US wind bonds
6
Source: Twelve Capital. As of 31st July 2013.
ILS Market Overview
US Wind Historical Returns
A Story of Marriage….
Swiss Re US Wind Price Return Index SRUSWPRC
103
102
101
100
99
98
97
96
95
1
8
15
2002-2011
•
•
•
22
29
2012
36
43
50
Week
2013
Cat Bonds are built on an long lasting, established reinsurance market
What happens to the reinsurance market affects the smaller Cat Bond market
Investors know the implications and draw conclusions
Source: Swiss Re. as of 13th September 2013.
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ILS Market Overview
Investors Overview
Cat Bonds Investors Breakdown: 2007 versus 2012
Investors Snapshot 2007
7%
Investors Snapshot 2012
Dedicated Fund
1%
Dedicated Fund
14%
Reinsurer
Reinsurer
AM
11%
Hedge Fund
Insurer
AM
4%
Hedge Fund
3%
Insurer
Bank
Pension Funds
12%
56%
61%
1%
13%
•
•
•
17%
More “sticky” money today, more sophistication
The market has become more mature
The collateralized reinsurance market is also developing in that direction
Source: Swiss Re Capital Markets. As od 31st December 2012.
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ILS Market Overview
Investors Overview: Pension Funds
USD 800bn
USD 45bn
Pension Funds Estimated Market
Potential Investment Size for Pension
Funds
ILS Market Size
USD 20'000bn
•
Assumptions
−
5'600 European insurances investing 4% average of their assets
−
Conservative estimation of the Pension Funds Market Size of USD 20tn
Source: Mercer Survey as of 20th May 2013 “European Asset Allocation Survey – LDI Strategies and Alternatives in Focus”.
Data in USD billion.
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Recent Observations
All Cat Bonds - July 2013 versus April 2012
14
12
Multiples (Spread/EL)
10
8
All Cat Bond - Apr 2012
6
All Cat Bond - Jul 2013
1
Trendline - Apr 2012
1
Trendline - Jul 2013
4
2
0
100
200
300
400
500
600
700
800
Expected Loss (EL) in bps
1
Method: using the exponential trendline functionality in Excel
Source: Twelve Capital.
10
Recent Observations
Market Cycles by Class
Managing the Soft Market
•
Comparing different underlying asset classes within the ILS market we see that different pricing cycles are observed
300
US Cat
reinsurance
280
Internat. Cat
Reinsurance
260
Property
reinsurance
240
Marine Hull
220
Offshore
energy
200
180
160
140
120
100
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Jan
Jun
2013 2013E
•
Looking at a broader range of underlying insurance asset classes allows us to enter niche markets as pricing improves
•
During 2013 we have sourced transactions in classes where pricing has increased substantially as an after effect of
losses our investors did not pay: Australia/New Zealand, US Crop, Marine
Source: Amlin plc. renewal rating index; June 2013 renewals estimates by Twelve Capital.
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Recent Observations
Private ILS versus All Cat Bonds – July 2013
18
16
Multiple (Spread/EL)
14
12
10
Private ILS - Jul 2013
All Cat Bond - Jul 2013
8
Trendline - Private ILS
6
1
Trendline - All Cat Bond
1
4
2
0
0
1
200
400
600
Expected Loss (EL)
800
1000
1200
1400
Method: using the exponential trendline functionality in Excel
Source: Twelve Capital.
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Recent Observations
Examples of Recent Transactions Closed
Selected Private ILS closed in Q2 2013
Private ILS
Crop Insurance
Private ILS
Terrorism Cover
Private ILS
Dual Trigger US Wind
Risk assumed
Agricultural crop insurance in the
USA
Risk assumed
Physical damage to property due
to terrorism worldwide
Risk assumed
Damage to oil exploration
platforms due to hurricanes
Transaction
basis
Indemnity reinsurance contract
Transaction
basis
Swap
Trigger
Losses to underlying portfolio
exceeding a certain level
Trigger
Trigger 1: Hurricane Cat 3 in
defined geographic location
Trigger 2: Total loss of certain oil
exploration platforms
Tenor
6 months
Economics
Approx. 13% return (0.8% EL)
Collateral
IBRD note
Transaction
basis
Indemnity reinsurance contract
Trigger
Abnormal weather causing physical
damage to crop combined with
yield produced is less than
estimated at the time of planting
Tenor
12 months
Tenor
12 months
Economics
Approx. 17% annual return
(5.0% EL)
Economics
Approx. 10% annual return
(3.3% EL)
Collateral
US T-bills
Collateral
IBRD note
Transaction rationale: Transaction benefits
from increased premiums in the crop
insurance market post last year’s losses.
Source: Twelve Capital.
Transaction
rationale:
transaction
represents a well paying diversifier.
Transaction
rationale:
Transaction
benefits from attractive multiple due to
highly tailored coverage for a corporate.
13
ILS investing, underwriting
Investment Process Cat Bonds
Sourcing
Analysis
Process: Investment
Case, Rating Framework
•
Each bond is analyzed
according to multiple
attributes, among which:
−
−
−
−
Collateral structure
Portfolio
Construction
Pricing
Packaging
Selection of a Cat Bond
•
Investment cases form the basis for
the selection of bonds. Each bond is
allocated either: attractive, cautious or
decline which will define the weighting
in the funds:
Trigger mechanism
−
Risk measures (loss
probabilities)
Decline  these bonds will never be
bought
−
Redemption features,
reset mechanism
Cautious  market weight or
underweight
−
Attractive  PM can overweight but
not more than 1% more than market
−
Attractive  Position is not larger
than 2.5% of NAV of vehicle
•
Diversification of bonds in the fund is
key for sustainable performance. We
use several levels of diversification:
−
Perils diversification, very high 
reduction of draw down risk
−
Type of triggers, high  reduction of
risk of unexpected reserve
development in indemnity bonds
−
Sponsor of bond  reduction of
available bonds as retreat of sponsor
reduces available securities
−
Repurchase counterparty, high 
reduction of collateral loss due to
counterparty default
−
Number of transactions, very high 
reduction of risk of unknown
structural flaws
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ILS investing, underwriting
Underwriting and Pricing
Underwriting, What is It?
•
Collection of data to allow for best possible risk judgment
•
Analysis of data, preparation of data for analysis
•
Determination of risk measures (expected loss, VaR, Standard Deviation…)
•
Review of legal wording
•
Interaction with cedant and broker
•
Engaging in structuring and closing the transaction together with Legal Dept.
•
Preparation of renewals (review data quality, close gaps, assess profitability...)
 Underwriter should have a rather good level of information of an insurance company
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ILS investing, underwriting
Underwriting and Pricing
Pricing a “Risk”
Expected
Loss
− Stochastic
− Burn
− Exposure
−Profit
Loading
Risk
Loading
− Unmodeled
− Uncertainty
for modeled
− Add load for
profitability
Other
Loads
− Add load for
brokerage
Quote
What we are
offering to the
broker (i.e. our
price)
Determination of
“known” risk premium
Technical rate; determination of total risk premium
Net price; determination of long-term profitability
Gross price; Load for other transaction costs e.g. brokerage
16
ILS investing, underwriting
Cycle management
The State of the Market: Two Fundamental Cycles drive Market Pricing over Time
•
Supply and Demand of Capacity
Capacity is scarce
Relative Price
Abundant capacity
Time
•
Annual seasonality of windstorms in peak regions: US Hurricane, European Winter Storm, Typhoon
−
−
Storm season forecasts affect protection buyer’s appetite and protection seller’s pricing
Prices will increase after major losses as protection sellers seek pay-back
Source: Twelve Capital.
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ILS investing, underwriting
Information asymmetry
Forms of information asymmetry…
... and ways out of it
•
•
Insurance is opaque:
−
−
−
•
Long tail business is not (yet) lending itself well for collateralized
reinsurance
Development of reserves
In-depth knowhow of IBNR
•
For short tail business: „submission pack“ provides in-depth
information on the company at stake
Premium development, acquisition costs
Only bad business is given to the financial
market (cession bias)
−
−
−
−
Due diligence  depth, data
Asking the right questions is the skill...(underwriting)
Renewal process is key  trust
This is a „normal“ process
 systematic tendency to reduce asymmetry
•
Reinsurers buy protection only if they have to (bias to retain)
−
−
−
−
Luck is not skillful
Processes and systems make it almost impossible to carve out
bad business
Underwriter decides on business
Who says its bad?  is there the right price for it?
18
Outlook
Current Market Outlook
The Pricing Cycle: Where are We Today?
•
Supply and demand of capacity
−
−
•
Abundant capital is available in the market
However, the new capital is mostly targeting specific areas which are easiest to access and require least
underwriting skill (US Wind ILWs)
Annual seasonality of windstorms in peak regions
−
−
Recent years have been relatively loss free in peak markets despite Hurricane Sandy
Pay-back pricing is available in niche markets but is difficult to access without contacts and underwriting
skills
•
Therefore, overall pricing is softening in property lines
•
Specialty lines are either at lows but others may hold more firm
19
Outlook
Current Market Outlook
What contributes to the Attractiveness….
•
•
•
•
•
•
Insurance is opaque for most observers
( premium, alpha?)
(Re)insurance is a market which is
established, rules are clear…. (trust,
renewals)
Returns from cat bonds are weakly
correlated to financial markets (Lehman,
Government yields  chart)
Collateralized reinsurance is uncorrelated
to financial markets
“Big” events result in higher spreads, more
than a promise (e.g. Katrina, Tohoku,
Deepwater Horizon)
Sophistication of market: we should be
expecting innovation
Chart: timeseries 31 May 2013 – 8 Sept 2013:
•
•
Recent interest rates increases had a strong effect on high yield
bonds (volatility!)
Return -0.9% , Volatility 5.4%
Twelve ILS fund was not affected at all by this
Return +0.9% , Volatility 0.5%
Source: Bloomberg, Twelve Capital.
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Twelve Capital ILS Strategy
Conclusions
ILS Market will grow
•
Current and expected economy fosters ILS as attractive asset class
•
Large demand will bring supply to market
•
Supply/Demand meet  innovation (Pizza to grow)
•
Innovation  novelty premium
Asymmetry
•
The size of the asymmetry hill is not insurmountable (underwriting)
•
Traditional reinsurance builds on trust
Attractive Market
•
Risk adjusted spreads are attractive
•
Collateralized reinsurance for underwriters
•
Cyclicality provides “guarantees” to come back to par post event
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Disclaimer
The products and services described herein are not available nor offered
to US persons and may not (and will not) be publicly offered to persons
residing in Switzerland, or any other country restricting the offer of such
products or services.
including the possible loss of the amount invested as described in detail
in the offering memorandum(s) for these instruments which will be
available upon request. Investors should understand these risks before
reaching any decision with respect to these instruments. Past
performance is no indication or guarantee of future performance.
This material has been furnished to you solely upon request and may not
be reproduced or otherwise disseminated in whole or in part without prior
written consent from Twelve Capital AG. The information herein may be
based on estimates and may in no event be relied upon. Twelve Capital
AG does not assume any liability with respect to incorrect or incomplete
information (whether received from public sources or whether prepared
by itself or not). This material does not constitute a prospectus, a
request/offer, nor a recommendation of any kind, e.g. to buy/subscribe or
sell/redeem investment instruments or to perform other transactions.
The investment instruments mentioned herein involve significant risks
Twelve Capital AG
Dufourstrasse 101
8008 Zurich, Switzerland
Phone +41 (0) 44 5000 120
info@twelvecapital.com
www.twelvecapital.com
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