Casualty Actuarial Society “Risk Securitisation 101”: Casualty Actuarial Society “Risk Securitisation 101” Kymn Astwood, CA
Arrow Reinsurance Company, Limited
(A Goldman Sachs Group Company)
16th October, 2000
Agenda: Agenda Insurance and the Capital Markets are Converging Benefits of Risk-linked Securities Risk Transfer vs Risk Financing Overview of the Risk-linked Securities Sector Weather Derivatives and Other Alternatives Structure of Risk-linked Securities
Insurance and Capital Markets are Converging: Insurance and Capital Markets are Converging
Insurance and Capital Markets are Converging: Insurance and Capital Markets are Converging Pricing and volatility for insurance and reinsurance
1999 – second worst catastrophe year for the P&C industry
Weather hedging driven by utility deregulation
Portfolio credit hedging driven by BIS rules, cyclical considerations
Availability of coverage for high capacity/new exposures Securities rulings and opinions
Standard documentation
SVO rating guidelines Modeling firms
Academic and government-sponsored research
Internet-based data accessibility
Rating agency expertise Concern over correlation – particularly in down markets
Desire for more concrete risk assessment
“Alpha-driven” investing Corporations,
Traditional
Insurance and
Reinsurance
Markets Legal and
Regulatory
Infrastructure Risk
Assessment
Technology Capital
Markets New
Risk
Instruments
Risk Markets Group: Risk Markets Group
Accessing Multiple Markets for Risk Management – Past Example : Accessing Multiple Markets for Risk Management – Past Example Risk management program shown was designed for an optimal mix of coverage from reinsurance and capital markets
Accessing Multiple Markets for Risk Management – Past Example : Accessing Multiple Markets for Risk Management – Past Example Risk management program shown was designed for an optimal mix of coverage from reinsurance and capital markets
Accessing Multiple Markets for Risk Management – Past Example : Accessing Multiple Markets for Risk Management – Past Example Risk management program shown was designed for an optimal mix of coverage from reinsurance and capital markets
Accessing Multiple Markets for Risk Management – Past Example : Accessing Multiple Markets for Risk Management – Past Example Risk management program shown was designed for an optimal mix of coverage from reinsurance and capital markets
Risk Management Alternatives: Risk Management Alternatives
Risk Management Alternatives: Risk Management Alternatives Risk
Intermediary FONDEN
Overview of Coverage Types: Overview of Coverage Types Types of Coverage Premiums paid at levels exceeding the market price of risk. Excess builds up in a fund which is returned if there is no loss Pre-Funded Coverage Payout determined and paid post-event. It is repaid over time. There may be a small option premium paid in advance Post-Funded Coverage A premium is paid in advance equaling the market price of risk Risk Transfer Coverage ———————Risk Financing Options ——————
Impact of Market Forces: 9 Impact of Market Forces Securitization will become increasingly cost competitive with reinsurance because of the forces driving both the markets Reinsurance
Hardening of retrocessional markets
Problems in Australian insurance market
Earthquakes in Turkey, Taiwan, Greece, Mexico
Hurricanes in U.S. and Central America
Higher satellite and aviation losses
Problems with workers compensation market due to Unicover-managed pool
Pressure to increase premiums to restore investor confidence in insurance/reinsurance stocks
Industry consolidation Securitization
Stable spreads with respect to BB corporate bonds
Lower transaction costs
Increased investor comfort with the asset class
Overview of the Risk-Linked Securities Sector: Overview of the Risk-Linked Securities Sector
Overview of Risk-Linked Securities: Overview of Risk-Linked Securities Securities whose returns are linked on the occurrence of events
Ratings based on the probability of event occurrence
Credit risk (as opposed to event), is generally minor
High grade investment trust account
Additional credit support
Most bonds floating rate, 1-5 years
Evaluating Risk-Linked Securities Quantifying Default Risk: Evaluating Risk-Linked Securities Quantifying Default Risk Probability in % Losses in USD Risk-linked securities typically transfer risk in the extreme “tail” of the probability curve - low frequency but high severity 0 100 75 50 25 Shown on next page
Evaluating Risk-Linked Securities Typical Structure: Evaluating Risk-Linked Securities Typical Structure Retention Securitized Risk Layer 0.2% 1.0% Exhaustion Point Attachment Point Expected Loss 0.2% 1.0% Probability
(cumulative) Coinsurance Losses ($)
Sectors of the Risk Securitisation Market: Sectors of the Risk Securitisation Market
Sectors of the Risk Securitisation Market: Sectors of the Risk Securitisation Market
Sectors of the Risk Securitisation Market: Sectors of the Risk Securitisation Market Gerling "SECTRS"
$500M Freddie Mac
"MODERNs"
$243M
Sectors of the Risk Securitisation Market: Sectors of the Risk Securitisation Market Gramercy Place
(Toyota Motor Credit)
100%
Sectors of the Risk Securitisation Market: Sectors of the Risk Securitisation Market
League Table As of September 2000: League Table As of September 2000 Number of Issues 24 5 5 3 5 1 3 3 3 1
Market Profile of Risk-linked Securities: Market Profile of Risk-linked Securities
Market Profile of Risk-linked Securities: Market Profile of Risk-linked Securities
Market Profile of Risk-linked Securities: Market Profile of Risk-linked Securities
Current Investor Profile Catastrophe Transactions: Current Investor Profile Catastrophe Transactions Chicago 8.5% San Francisco 23.8% Vancouver 0.2% New York
51.0% Boston 2.9% London 5.2% Frankfurt 3.4% Milan 0.2% Paris 1.0% Toronto 2.7% Tokyo 1.6% Proprietary/ Hedge Funds
21.9% Reinsurers/ Intermediaries 21.0% Banks
8.2% Mutual Fund/ Investment Advisor 28.9% Life Insurers 16.6% Non-Life Insurers 3.9% 118 Institutional Investors
Benefits of Risk-Linked Securities: Benefits of Risk-Linked Securities
Benefits of Risk Securitization Issuer Perspective: Benefits of Risk Securitization Issuer Perspective Diversification of sources of risk protection
Additional capacity for certain risks / geographic areas
No credit risk due to full-collateralization of securities
Prompt claims payment following a loss event
Clearly defined trigger reduces disputes regarding covered claims
Multi-year coverage at a fixed cost may be locked in at inception
Market perception as an innovator and industry leader
Benefits of Risk Securitization Investor Perspective: Benefits of Risk Securitization Investor Perspective Uncorrelated Diversification can be achieved due to low correlation with equity and fixed income investments
Risk-Linked Securities Pricing and Market Spreads: Risk-Linked Securities Pricing and Market Spreads fjjephson: rmgeurope00/investors/spreads 01.xls (Cat Spreads PPT)
Risk-Linked Securities Non-Correlation and Outperformance in Turbulent Markets: Risk-Linked Securities Non-Correlation and Outperformance in Turbulent Markets (a) Trinity Re, Residential Re, Mosaic Re, Pacific Re, Parametric Re
Risk-Linked Securities Non-Correlation and Outperformance in Turbulent Markets: Risk-Linked Securities Non-Correlation and Outperformance in Turbulent Markets (a) Trinity Re, Residential Re, Mosaic Re, Pacific Re, Parametric Re
Benefits of Risk Securitization Investor Perspective: Benefits of Risk Securitization Investor Perspective Uncorrelated Diversification can be achieved due to low correlation with equity and fixed income investments
Attractive Risk/Return Profile compared with similarly rated corporate bonds
RLS Offer Higher Returns Than Similarly-Rated Securities: RLS Offer Higher Returns Than Similarly-Rated Securities Portfolio of Risk
US Hurricane
US Quake and Wind
Japanese Earthquake
US Quake
Typhoon
Weather Expected Loss (%) Spread to LIBOR (%)
Benefits of Risk Securitization Investor Perspective: Benefits of Risk Securitization Investor Perspective Uncorrelated Diversification can be achieved due to low correlation with equity and fixed income investments
Attractive Risk/Return Profile compared with similarly rated corporate bonds
Sophisticated Risk Analysis is performed by independent catastrophe-modeling firms
The Role of the Expert Modeling Firm Providing a Level Playing Field for Investors: Expertisation of Analysis Objective 3rd-party quantification Due diligence No “black box” models Multi-dimensional technical support Education for all constituents Proven catastrophe modeling technology Rating Agencies The Role of the Expert Modeling Firm Providing a Level Playing Field for Investors
Benefits of Risk Securitization Investor Perspective: Benefits of Risk Securitization Investor Perspective Uncorrelated Diversification can be achieved due to low correlation with equity and fixed income investments
Attractive Risk/Return Profile compared with similarly rated corporate bonds
Sophisticated Risk Analysis is performed by independent catastrophe-modeling firms
Liquidity is provided by the growing secondary market trading of risk-linked securities
RLS – Market Liquidity Secondary Trading Volume: RLS – Market Liquidity Secondary Trading Volume
Hurricane Bonds Trade Actively Through Storm Events: Hurricane Bonds Trade Actively Through Storm Events MGCharles:
Rmg99/hurricane map_2.cdr
Basic Structure of Risk-Linked Securities: Basic Structure of Risk-Linked Securities
Risk Securitisation Basic Structure: Risk Securitisation Basic Structure
Slide43: Case Study
Alpha Wind 2000-A Ltd. Hurricane Risk Securitization (State Farm Insurance Group)
Summary Structure: Summary Structure Trust Premium Retro
Contract Proceeds Securities Reinsurance
Contract Premium
Slide45: Case Study
Concentric / Circle Maihama Earthquake Risk Securitization (Oriental Land Co. Ltd.)
Slide46: April 1999 Circle Maihama, Ltd. Floating Rate Extendible Notes (FRENs) Concentric, Ltd. Floating Rate Principal-at-Risk Notes
Case Study: Circle and Concentric: Case Study: Circle and Concentric
Case Study: Circle and Concentric Summary of Terms: Case Study: Circle and Concentric Summary of Terms
Case Study: Circle and Concentric Underlying Earthquake Exposure: Case Study: Circle and Concentric Underlying Earthquake Exposure
Slide50: Weather Risk Hedging
Weather Risk Management : Weather Risk Management First weather derivative traded in 1996
$5 billion of weather derivatives executed to date
Estimated market growth $70 to $100 billion
Estimated that $1 trillion of $7 trillion U.S. economy subject to weather risk
Impact of Weather on Business: Impact of Weather on Business Weather Utilities Municipalities Beverage Producers Agricultural Industry Energy Industry Resorts
Impact of Active Risk Management Investment Research on Peoples Energy Corp.: Impact of Active Risk Management Investment Research on Peoples Energy Corp. “We are initiating coverage of Peoples Energy with a Market Performer Rating” 9/14/1999 10/28/1999 1/20/2000 2/15/2000 4/24/2000 “Strong FY1Q despite warm weather … $0.05 positive EPS impact of weather insurance … We continue to rate PGL shares Market Outperformer” “Strong FY2Q despite warm weather because of weather insurance … This weather insurance to date has already paid significant dividends – earnings would have been hurt an additional $0.17 year to date if no weather insurance had been purchased … Market Outperformer” “We are raising our rating on PGL to Market Outperformer … Peoples recently announced it purchased a weather insurance policy that would limit the company’s annual EPS risk from warmer than normal weather to about $0.25 … while retaining all of the upside” “Reducing FY00 estimates due to weather … Although weather has once again proved disappointing, we continue to view the purchase of insurance favorably because it does limit the downside risk … Maintain Market Outperformer Rating”
Weather Risk Hydro Power : Weather Risk Hydro Power Drought
Slide55: Case Study
Kelvin Ltd. Weather Risk Securitization (Koch Energy Trading, Inc.)
Case Study: Kelvin, Ltd Weather Risk Securitization: Case Study: Kelvin, Ltd Weather Risk Securitization Koch Energy and Trading, Inc, a subsidiary of Koch Industries, Inc.
One of the largest privately held corporations in the United States
Based in Wichita, Kansas with more than 16,000 employees worldwide
A diversified company involved in oil and gas, chemicals, plastics, energy services, chemical and environmental technology products, asphalt products, metal and mineral services, agriculture and financial services
To manage weather risk embedded in Koch’s energy and agricultural businesses
To create capacity in order to offer customer solutions
To broaden investor participation in the weather market
Case Study: Kelvin, Ltd Weather Risk Securitization: Defined Portfolio Notional Amount and Risks Case Study: Kelvin, Ltd Weather Risk Securitization 40 25 25 25 25 Sioux Falls Milwaukee Columbus Baltimore New York Covington Sault
Ste. Marie Chicago Oklahoma City 4 10 Indianapolis 10 35 10 San Francisco Bismarck Covington Portland Cleveland Green Bay Sault Ste. Marie 15 15 Charlotte Oklahoma City 15 Columbus Sioux Falls Oklahoma City Philadelphia 10 3 Tampa San Francisco 4 2 5 2 15 Investor risk is cold winter Investor risk is warm winter Investor risk is hot summer Investor risk is cool summer, warm winter and cold winter (freeze) Birmingham 2 3.5 3.5 3 4 3.5 2
Case Study: Kelvin, Ltd Weather Risk Securitization: Case Study: Kelvin, Ltd Weather Risk Securitization Kelvin, Ltd
First Event Weather-Linked Fixed Rate Senior Notes
$22 million
February 14, 2003
15.80% (at risk)
B- (DCR)
Coupon Reduction: 12.1% First Dollar: 9.2% Full Reduction: 0.5%
4.45% Kelvin, Ltd
Second Event Weather-Linked Fixed Rate Senior Notes
$23 million
February 14, 2003
8.70% (at risk)
BBB-/BB+/BB (DCR/Fitch/S&P)
0.60% Summary of Terms
Derivative Transactions Accessing Reinsurance from Investors -- Selected Examples: Derivative Transactions Accessing Reinsurance from Investors -- Selected Examples State Farm/Tokio Marine Swaps (April 2000)
Traded $200m of Japanese earthquake exposure for Midwest earthquake directly
Oriental Land Currency Swaps (May 1999)
Ability to pay premium and receive compensation in Japanese yen for a $USD risk-linked security
CAT Ltd. Hurricane Swap (July 1997)
$35m of East Coast U.S. wind coverage linked to terms of Residential Re securities
Derivative transactions offer the ease of execution of reinsurance, and permit investors in the capital markets to supplement a reinsurance program
Slide60: Arrow Reinsurance Company, Limited
(A Goldman Sachs Group Company)
16th October, 2000 For additional information regarding this presentation, please contact:
Kymn Astwood
441 296 8107
kymn.astwood@gs.com