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Slide 1: 

Alternative Sources of Capital for Insurance Companies 2000 Life Convention “Making the most of Life” Birmingham, 13 November 2000 Achim Bauer, Managing Principal Swiss Re New Markets UK Ltd. (London) David Howell, Corporate Risk Management Actuary Swiss Re Life & Health (London)

Agenda: 

2 Agenda What is capital? Why do insurance companies need it? What are the traditional sources of capital? What are some of the alternatives? Reinsurance Hybrid instruments

What is capital?: 

3 What is capital? Statutory Capital vs. Rating Capital*1 Market value of assets - Statutory value of liabilities - Resilience test reserves - Solvency margin = Free assets => Statutory Capital CAR*2 = Total adjusted capital - Asset risk for non-profit business Asset risks for with-profit business + Pricing risk + Reserving risk + General business risk *2 CAR = *1 S&P’s Capital Adequacy Model

Why do insurance companies need it?: 

4 Why do insurance companies need it? Office’s Capital Strategy Regulators Require high solvency margin Adopting international standards Major changes in definition Diversified capital sources Policy holders Require solid financial strength Performance by reducing costs Rating agencies Adopting consistent standards Recognising cost and capital Requiring diversified capital base Management Benchmark performance Broad investor base Required flexibility Support new business writing Smoothing pay-outs for with- profits business Financing an acquisition Competitors International and domestic Access to capital via listing Lower cost of capital

Current pressures on capital: 

5 Current pressures on capital Impact of low interest rates guaranteed annuity options strengthening of reserves competitiveness of products Stakeholder type product design pressure on absolute charges trend towards back-end loads removal of surrender penalties the need to grow Greater awareness of financial strength Greater focus on statutory/rating capital

Optimizing capital utilization: 

6 Optimizing capital utilization  Goal: Secure survival of the company while maximizing ROE Sources of improved capital management Utilize capital better / take more risk Restructure capital base Hold less capital Asset allocation & ALM Reinsurance programs More profitable business Reduce equity and increase leverage Dividends Share buy-backs

Sources of capital - the insurative model: 

7 Sources of capital - the insurative model

Traditional sources of capital: 

8 Traditional sources of capital Equity injections from shareholders Retained profits Unattributed assets built up from past generations of policy holders The excess of asset shares over statutory reserves for with-profits business Section 68 order for implicit items Sub-ordinated debt Demutualisation

Alternatives and considerations?: 

9 Alternatives and considerations? Create loss absorbing capital which is non-dilutive to common capital base Create prudent leverage of common equity Optimise solution, taking regulatory, accounting and tax requirements into account Provide long-term solutions

Corporate risk financing instruments: 

10 Corporate risk financing instruments Degree of transfer Degree of complexity Hybrid Contingent capital Insurance-linked securities Multi-line/ basket Finite re/insurance Risk bundling Conventional re/insurance Risk Financing Risk Transfer

Principles of financial reinsurance: 

11 Principles of financial reinsurance Future valuation surpluses are normally an inadmissible asset Financial reinsurance converts the inadmissible value into an admissible asset Can be achieved through increasing assets (cash financing) or decreasing liabilities (non-cash financing)

Cash financing: 

12 Cash financing Cash financing provides a reinsurance advance which is repaid with interest from future regulatory surplus Repayment is directly contingent on future surplus actually emerging No liability to repay is established Regulatory Capital is increased by the amount of the cash payment Before After

Non-cash financing: 

13 Non-cash financing Cashless financing reduces liabilities without requiring an initial premium Liabilities are recaptured over time from emerging surplus Regulatory Capital is increased by the amount of the release Greater impact on the FAR than cash financing as there is no dilution effect Before After

Principles of financial reinsurance: 

14 Principles of financial reinsurance A number of deals have already been completed Transaction sizes can be anything up to GBP 1bn+ Competitive source of statutory capital for life offices Development to accommodate with-profits business

With-profits business: 

15 With-profits business With-profits business traditionally not used for supporting financial reinsurance structures issues around PRE difficulties interacting with valuation Structures developed using an appropriate definition of surplus Large transactions can be supported from these structures Non-cash basis has been more commonly used so far

Efficient capital management - Contingent Capital: 

16 Efficient capital management - Contingent Capital Description Contingent Capital solutions provide clients with the capital they need to finance recovery after a catastrophic event. Capital access may be through a credit facility, surplus notes or preferred stock.

Efficient capital management - Contingent Capital (continued): 

17 Efficient capital management - Contingent Capital (continued) Advantages Provides necessary capital to master a post event-situation (“just in time”) Cost efficient Increases future flexibility at fixed cost Addresses customer’s credit quality concerns Ensures continued financial strength in a post-event situation Allows differentiated management response to post-event market conditions Reduces threat of a rating downgrading

Slide 18: 

18 0 Result Distribution Capital Risk Adjusted Capital Depletion Capital Risk Tolerance Level “Survival Probability” “Ruin Probability” Probability Contingent capital as part of RAC

The rationale for Contingent Hybrid Capital: 

19 The rationale for Contingent Hybrid Capital Rating Agency Issuer Regulator Shareholder Prudent Leverage of Capital Base Long term bridge Capital Predetermined pricing Potential Equity treatment by Rating Agencies No dilution for shareholders when issued Adds up to Solvency Capital

Contingent Capital - key features: 

20 Contingent Capital - key features Swiss Re is committed to buy preferred capital securities at predetermined cost and terms Commitment triggered by a clearly defined event (e.g. value of in force drops below a level of 75%, “once in a century”) and can be determined with regulators and rating agencies Client pays annual premium (tax-deductible) Multiyear coverage term from “AAA” provider Once issued, the securities may carry a tax-deductible coupon

Contingent Capital - effects of the commitment: 

21 Contingent Capital - effects of the commitment The client realizes the VIF-credit usually given by S&P in their Capital Adequacy Model up to 75% which compares to the standard VIF-credit of 50% With this value secure, the client has a significantly increased investment/ definancing flexibility Total adjusted capital - Asset risk for non-profit business Asset risks for with-profit business + Pricing risk + Reserving risk + General business risk *2 CAR = *1 S&P’s Capital Adequacy Model

Securitization: 

22 Securitization Life insurer “sells” future profits emanating from a defined bloc of business to investors Investors “borrow” money against future profits emanating from a defined bloc of business of the life insurer Financing of acquisition costs A Special Purpose Vehicle (SPV) company takes the role of the reinsurer

Securitization - possible structure: 

23 Securitization - possible structure Life Insurer SR SPV 1 Initial reinsurance commission Investors 3 Liquidity 4 Guarantee 2&3 Coupon & Amortisation 1 Bond 2 Reinsurance premium Fee SPV pays a “loan” which is financed by issuance of a bond Debt service through profits of securitized bloc of business In case profits are inferior to debt service SR provides a facility which covers the difference (spread-loss arrangement) SR (through SR Financial Products) guarantees the amortisation if the surpluses fail to materialize (risk transfer) SR enhances the transaction through guarantees 3 and 4 with its AAA-Rating thereby lowering the cost of financing for the transaction

Securitization - considerations: 

24 Securitization - considerations Investors prefer amortisation with well predictable cash flows, hence the adding of a “guarantee” facility Bond has to be rated in order to attract investors Set up of a Special Purpose Vehicle If reinsurance transaction between life insurer and SPV, then SPV needs a reinsurer license Expenses for documentation and rating agencies

Slide 25: 

Alternative Sources of Capital for Insurance Companies 2000 Life Convention “Making the most of Life” Birmingham, 13 November 2000 Achim Bauer, Managing Principal Swiss Re New Markets UK Ltd. (London) David Howell, Corporate Risk Management Actuary Swiss Re Life & Health (London)