Retrocession vs. Alternative
Markets in Managing a
Reinsurers Accumulations
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 1
Initial Summary
 There is an ample supply of capital to service the
catastrophe capacity requirements of any emerging
market
 Emerging markets present an attractive opportunity
for further reinsurance or ART market diversification
 It makes long term economic sense for any
developing economy to take advantage of this capital
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 2
Agenda
 Introduction
– Some key points
 Interpretation of who a “National Reinsurer” might be
 Transfer mechanisms for attaining Nat Cat capacity
and diversification
– Traditional reinsurance/retrocession
– Alternative market solutions
 Summary
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 3
Introduction
 Swiss Re is a large Global Property, Casualty, and Life
Reinsurer with over 29 Bn (CHF) earned premium volume.
 In addition to traditional reinsurance Swiss Re has been a
leader in facilitating Alternate Risk Transfer (ART) solutions
including being active in the development of the insurance
linked-securities (ILS).
Progressive failure on
the North Anatolian fault
- Ross Stein USGS
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 4
 Swiss Re has sponsored
independent studies
throughout the world and
has dedicated internal
resources into researching
natural catastrophes
 Swiss Re has partnered with many non-profit organizations in
making our expertise and experience available to support
governments and society in developing strategies to mitigate
the effects of natural disasters
Key Points
 There is an ample supply of capital to service the
catastrophe capacity requirements of any emerging
market
There are only a
few regions where
the the peak
amount of
traditional
reinsurance may
be too
concentrated
Throughout
most of the
world the
opportunity to
diversify is
attractive and
cost effective
to resinsurers
and cedants
alike
 Emerging markets present an attractive opportunity for
further Traditional or ART market diversification
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 5
 This capital can be accessed through traditional
Reinsurance, Retrocession or through various
Alternative Risk Transfer markets including the Capital
Markets
Key Point - Capacity at need?
World wide peak risks are an issue for the reinsurer prompting their
need for more diversification and required capacity.

There is
approximately $24
Billion US in
available
catastrophe
capacity
WS Belgium
EQ South Africa
WS Netherlands
EQ Israel
Ideal level reinsurance would take for optimal
diversification
EQ Columbia
EQ Portugal
WS Germany
EQ Mexico

Approximately $3
Billion in
Insurance Linked
securities
EQ Italy
EQ Australia
Peak risks would ideally be ceded
to capital markets, which are better
able to diversify these risks
WS France
EQ Canada
EQ New Madrid (*)
EQ Japan
TC Japan
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 6
WS UK
EQ California (*)
TC Atlantic (*)
(*) Estimated split based on SR book
Source: Swiss Re
World wide coverage
Key point
Is there sufficient cat capacity available?
 The availability of traditional Natural Hazard catastrophe
capacity is basically a function of:
– Accessible capital compared to exposed equity loss potential
– Realized rate vs. expected loss, expenses and cost of capital
– Diversification and appetite for “peak” risk in relation to the above
Earned premiums
Economic profit
Expected profit before tax Expected profit after tax
Taxes
Minimum price
covering all fixed
or expected costs
= “technical price”
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 7
Cost of Capital
Internal expenses
External costs (commission, brokerage)
expected loss based on loss experience, underwriting
expertise and application of sophisticated cat models
Interpretation of who can act as a
“National Reinsurer”
World Bank
National Government
Reinsurer
Retrocession
Reinsurer
Retrocession
Local Reinsurer
Reinsurance treaty
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 8
Insurance Company or
Insurance Pool
Insurance Policy
Property
Owner
Insured
A National Government often acts as a
reinsurer of last resort
In the current environment
Traditional
protocols
any onereinsurance
of these entities
suggest
thatasreinsurers
could act
a Nationaluse
retrocession
to expand
Reinsurer
andcovers
seek reinsurance,
capacity, diversify,
and reduce
retrocession,
or alternative
risk
exposures
transfer
support
Capacity and Diversification
There are two main reasons for seeking
Retrocession or Alternative Market Support
 Reduce loss potential
World Bank
National Government
Reinsurer
Reinsurer
Reinsurer
Insurance Company
Insured
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 9
 Increased need for capacity - expand the capital base
in situations where the potential loss exceeds the
financial capability of the risk bearer to absorb losses
– Sharing/expanding of capital increases the
insurer/resinsurer’s ability to absorb additional
risk
 Diversification of exposure - the ultimate goal of
insurance and reinsurance is to spread the risk.
– Diversification leads to more efficient pricing,
increased capacity, stability, and sustainability
Alternative Risk Transfer Markets
 What are they?
Turkish Catastrophe
Insurance Pool - TCIP
Risk Carriers
• Self insurance / captives
• Risk retention groups
• Pools
• Captive markets
Insurance Pool - TREIP
Indonesian Earthquake
Reinsurance Pool - IERP
EQ Council - EQC
New Zealand
California Earthquake
Authority - CEA
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 10
Alternative
Risk Transfer
Solutions
• Finite Risk re-insurance
• Contingent Capital
• Multi-year / Multi-line products (MMP)
• Multi-trigger products (MTP)
• New Asset Solutions
• Weather Derivatives
• Securitization / Insurance-Linked Securities (ILS)
Alternative Market Solutions

Finite Risk re-insurance
– Smoothing mechanism where risk transfer, financing and the
time value of money is emphasized

Contingent Capital
– Contractual commitment to provide capital in the form of
senior debt, etc. after an adverse eent

Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 11
Multi-year / Multi-line products (MMP) Multi-trigger
products (MTP)
– Consolidate and combine uncorrelated risks with a trigger
that is highly correlated to financial circumstances
Alternative Market Solutions
 New Asset Solutions (Structured Finance / Asset
backed Securities)
– Raising capital through the securitization of future cash
flows

Weather Derivatives

 Securitization
Securitization // Insurance-Linked
Insurance-Linked Securities
Securities (ILS)
(ILS)
– Innovative way of increasing insurance capacity by
accessing the capital markets via bond issue. Capital
received is transferred to a special purpose vehicles SPV
who then acts much like a traditional reinsurance company.
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 12
– Most ILS are natural catastrophe driven due to the ease
and transparency of identifying, isolating, understanding,
evaluating the risk
Insurance Linked Securities
Premium
Cedant
Cat Cover
Special
Purpose
Reinsurer
Vehicle
(SPV)
Bond Coupon
Bond
Investors
Bond Proceeds
The majority of ILS transactions to date have involved
Traditional
reinsurance
or retrocession
is an
catastrophe
bonds.
Typically three
parties are involved.
exchange
of premium
forthea SPV
transfer
risk cover.
Investors
purchase
bonds from
whichof
simultaneously
enters
contract
with
the cedant.
Theof
sole
In allinto
buta reinsurance
a few of the
“peak”
exposed
areas
purpose
of the SPV reinsurance
is to engage inis
thestill
business
relating as
to the
concentration,
considered
securitization.
the most economical and efficient risk
transference
of choice.is that a traditional reinsurance
One
of the main differences
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 13
program’s pay out is activated by the cedant’s actual
sustained losses. An ILS limit is paid immediately upon the
occurrence of a predetermined trigger and is priced
according to the limit and event exceeding probability.
Retrocession or ART
In many ways the same motivation exists for
purchasing a retrocessional cover or ART product
 Increase surplus/capacity to assume risk
– Corresponds to the ability to increase volume
 Reduce risk
– Transfer loss potential to another
 Stability
– Mitigate fluctuations in revenue or growth
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 14
 Diversify portfolio
– Optimize return/loss levels
Acceptance of ILS
To date most ILS transactions are in regions with high
severity, low frequency, peak exposures, and further need
for diversification
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 15
On top of a $2 Bn existing portfolio in 2002
Combined Art and
Traditional in Peak Exposed Areas
CEA $6,611 billion
Often an ILS is
combined with
traditional
reinsurance and
retrocession in order
to expand capacity
and diversification
$1,456
Post EQ
Industry Assessments
$338m
Second Cat Bond/Contingent
$200m
Transformer Layer
$617m
$100m
Line of Credit
$400m
Reinsurers must write
the same share
in Covgs A, B and C
Revenue Bond Layer
First Cat Bond/Contingent
$600m
Multi Layer Cat
Reins. Contract
Coverage C
Contingent Fourth
$338m xs $4,817b
Sold ROL 5.15%
Reins. 1st Layer
Post earthquake
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
$2,183
$717m
Page 16
Coverage B
Contingent Second
$400m xs $3.5b
Sold ROL 7.25%
Industry Assessments
CEA Capital
Coverage A
$600m xs $2,9b
First R/I Layer
ie- traditional
Sold ROL 8.80%
Expected Loss and Realized
Return or Selected InsuranceLinked Securities and Swaps
In most
cases the
ILS is more
costly then a
traditional
cover
Indicative technical
reinsurance pricing
for peak cat areas
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 17
Some comparison features of
ART vs Traditional to an Emerging market
Features
ILS
Traditional
Limits of
insurability
Increases capacity especially in peak
areas & independent of insurance
cycle
Perceived avoidance of low
frequency and high severity
events
Diversification
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 18
Capital markets are uncorrelated to
Areas of peak exposure have high
insurance - improving portfolio
areas of insurance concentration
diversification
Counterparty
credit risk
Investment grade securities held as
collateral servicing only specified
contract
Ratings uncertain especially
during times of industry duress or
extreme events
Multi-year
contracts
Multi-year programs of up to 10 years
have been issued
Natural catastrophe programs
typically run for one year
Flexible Loss
trigger
Three types, indemnity (cede
sustained loss), index (industry loss)
or parametrc (physical event
characteristic)
Tyically indemnity based but can
be somewhat flexible
Activation of
cover
Based on trigger regardless of actual
claims
Paid on development of cede
losses
Data
Flexible - pricing based on coverage
limit and event probabilities
Requires - pricing based on
expsoure data as well as limit
and event proabilites
Concluding observations Emerging Markets
 Local Reinsurance and insurance markets are
underdeveloped making the government a reinsurer
of last resort - exposures hard to identify
– Developing Risk awareness, transfer and mitigation strategies
 Low frequency/high severity events could endanger
the financial being of the local reinsurer or state
 Low country GDP - actual loss devastating in terms of
% GDP and future sustainability
 Need for immediate post event liquidity
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 19
 High capital demands for necessities
 Makes economic sense
Source: Swiss Re
Example*
GDP
$13.7 Bn .(2001)
5 earthquakes in the last 20 years
1986
$2.3 Bn (US)
2001
$1.7 Bn (US)
Other losses
$ . 4 Bn (US Total
$4.4 Bn
Average Loss $ 220+ Million per year
Average Loss $ 60 Million per year
Maximum Loss $2.3 Bn
Maximum Loss $100 MM
What if?
Country hedges itself through traditional or ART markets by purchasing a
$2.5 Bn cover with a $100 MM retention
Pure risk premium
Annualized deductible
Capital and other costs
Page 20
$28 MM per annum
$20 MM
?? $14 MM
* Not an offering or exact analysis
Final Summary
There is an adequate supply of capital to support the catastrophe
capacity needs of the merging markets
Reinsurance/Alternate Risk Transfer mechanisms promote financial
sustainability by reducing economic volatility due to Nat Cat shock
losses
Both the Traditional and Capital segments offer a variety of
solutions and are eager to diversify into new cat markets.
Reinsurance makes economic sense
Natural Disasters
World Bank - June 2-3
Andrew Castaldi - Swiss Re
Page 21