astwood

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 SecuritiesQuantifying 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 TableAs 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 ProfileCatastrophe 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 SecuritizationIssuer 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 SecuritizationInvestor Perspective: 

Benefits of Risk Securitization Investor Perspective Uncorrelated Diversification can be achieved due to low correlation with equity and fixed income investments

Risk-Linked SecuritiesPricing and Market Spreads: 

Risk-Linked Securities Pricing and Market Spreads fjjephson: rmgeurope00/investors/spreads 01.xls (Cat Spreads PPT)

Risk-Linked SecuritiesNon-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 SecuritiesNon-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 SecuritizationInvestor 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 SecuritizationInvestor 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 FirmProviding 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 SecuritizationInvestor 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 LiquiditySecondary 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 SecuritisationBasic 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 ManagementInvestment 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 RiskHydro Power: 

Weather Risk Hydro Power Drought

Slide55: 

Case Study Kelvin Ltd. Weather Risk Securitization (Koch Energy Trading, Inc.)

Case Study: Kelvin, LtdWeather 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, LtdWeather 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, LtdWeather 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 TransactionsAccessing 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