Morgan Schaeffer Insurance-Linked Securities: Overview 18.
Agenda Securitisations in general Structure & mechanisms Benefits to insurance companies
Securitisations in general Definition Securitisation Process that involves the isolation of a pool of assets or rights to a set of cash flows and the repackaging into securities traded in capital markets. Slide 3
Securitisations in general History and development 70 s: Securitisation of mortgage loans in the US. 80 s: 1985: securitisation of other types of assets: automobile loans credit card receivables commercial mortgage loans 1988: 1st securitisation involving insurer: sales of rights from life policies and annuities 90 s - now: 1992 CBOT: futures contracts securitising property losses from natural catastrophes Various CAT risk securities Increasing volume of life insurance and annuities securitisations Slide 4
Securitisations in general ILS Market: life securitisations $ bio 25 20 15 10 5 0 Source: Swiss Re 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 New issues Outstanding Slide 5
Securitisations in general ILS Market: non-life securitisations $ bio 18 16 14 12 10 8 6 4 2 0 Source: Swiss Re 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 New issues Outstanding Slide 6
Securitisations in general Examples of securitised risks Hurricane/Typhoon Tornado Mortality/Longevity Earthquake Morbidity Auto Insurance Flood Terrorism, PVFP, DAC And many others Slide 7
Agenda Securitisations in general Structure & mechanisms Benefits to insurance companies
Structure & mechanisms Structure and roles Ceding Company Premium = Risk Spread + Swap Spread + Expenses, e.g. 4m Reinsurance cover for e.g. 100m Total Return on Trust Assets Special Purpose Vehicle LIBOR Swap Spread Capital, e.g. 100m Securities Contingent Return of Capital + LIBOR + risk spread Rating Investors Swap Counterparty Rating agency Contingent Return of Capital: 1. No claim to ceding company: Investors receive full Capital (100m) + interest 2. Claim notified by ceding company: Investors receive remaining Capital (100m claim amount) + interest Slide 9
Structure & mechanisms Participants Rating agencies Important role for rated transactions Other participants Actuarial consultants Underwriters/structuring agents Legal counsel Slide 10
Structure & mechanisms Loss trigger types Insurance Reinsurance cover SPV Indemnity Based on actual claims Not very transparent Hard to price and most expensive Suitable for cedents that must receive coverage exactly matching their portfolio Loss development period required Modelled losses Claims / recoveries depend on loss output from a third-party model mirroring the issuer s portfolio, given peril s parameters Hybrid between indemnity and parametric Industry losses indexed losses Popular when concerns about moral hazard or adverse selection Most popular for cedents whose portfolio resembles that of the index Parametric Recoveries depend on objective parameters of the events Basis risk still exists between actual losses and recoveries from securitisation Slide 11
Agenda Securitisations in general Structure & mechanisms Benefits to insurance companies
Benefits to insurance companies Reasons for securitising insurance risks Increase capacity for growth Provide capacity Lack of capacity to provide adequate protection against major events for reinsurance market No market for particular risks Rise in attachment levels in hard markets Credit quality Credit exposure is to a fully-collateralised reinsurer Slide 13
Benefits to insurance companies Reasons for securitising insurance risks Reduction in costs of capital Securitisations as a tool to reduce cost of capital Idea: Reinsurance premium to be paid to transfer risk < Cost of Capital on Capital required to retain risk Reduction of needed capital through risk transfer Transparency and portfolio selection reduces Cost of Capital Slide 14
Benefits to insurance companies Reasons for securitising insurance risks Accelerate Balance Sheets Acceleration of the recognition / monetisation of assets: Swap PVFP or DAC against immediate cash amount Lock in future profits Use cash amount for: Acquisition New Business Potential rating improvement Slide 15
Benefits to insurance companies Reasons for securitising insurance risks ROE Enhancement R ROE Enhancement ( ) E Cash Life in-force / DAC Bonds Equities Real estate Alternative investments Technical Reserves life Technical Reserves non-life Debt Equity Source: Horizon 21 Securitisation: Reduction of capital need Lock in future profits Reduction of earnings volatility Share buy-back: Reduction of equity capital Slide 16
Summary Summary Increase capacity for growth Reduce Costs of Capital Enhance ROE Accelerate Balance Sheets Slide 17
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