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Risk Securitization vs. Traditional Reinsurance Gary Prestia Senior Vice President, Property Zurich Re (North America) October 23, 1998 Patrick Sullivan.

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Presentation on theme: "Risk Securitization vs. Traditional Reinsurance Gary Prestia Senior Vice President, Property Zurich Re (North America) October 23, 1998 Patrick Sullivan."— Presentation transcript:

1 Risk Securitization vs. Traditional Reinsurance Gary Prestia Senior Vice President, Property Zurich Re (North America) October 23, 1998 Patrick Sullivan Vice President Marsh & McLennan Securities Corp.

2 2 Insurance and the Financial Markets Convergence of insurance/reinsurance and financial markets Narrowing the many choices available (traditional reinsurance, CBOT, contingent surplus notes, CATEX, BCOE) Complimentary solutions of traditional reinsurance and securitizations Case Study Company profile of product lines, geographic spread and loss experience Catastrophe modeling analysis based on 5 digit zip unicede information. Discussion of expected loss curve profile Traditional and Non-Traditional Solutions Agenda

3 3 Key Risk Problem with Case Study n Primarly Exposed to Texas Gulf n Possibility of loss from very large, but very rare event n Is single-year insurance the best choice? l Price stability over time l Capacity stability over time l Credit risk of counterparties

4 4 Risk Profile Catastrophe Protection Analysis Limits (in millions) m 912 m 980 m 1.13 b 1.22 b Return Period Year Est Dollar Loss

5 5 Possible Solutions OptionsReason Quota ShareSurplus relief & ground-up risk & cat loss sharing Aggregate Excess of LossReduce frequency of losses Catastrophe Excess Reduce moderate to severe cat of losslosses Top end catastrophe coverage in form of Cat Bond Securitization or Contingent Surplus NoteReduce severe cat loss activity

6 6 Traditional Reinsurance Solution Catastrophe Protection Analysis Limits (in millions) 1998 Traditional Cat Reinsurance $1b xs $250m (3 layers) m 912 m 980 m 1.13 b 1.22 b Return Period Year Est Dollar Loss m 50% QS 50% Net Retention Aggregate Catastrophe $65m xs $60m Franchise Deductible - $30m

7 7 Traditional Reinsurance Advantages n Traditional solution, easy to understand and explain. Accustomed to traditional approaches n Less complicated, generally more quickly accomplished n When supply is plentiful, pricing/terms will be very attractive n Known regulatory and accounting treatment n Broad coverage (WC, ECO/XPL, reinstatement) n Historical track record and known entities. Longevity of commitment by professional reinsurers to the insurance marketplace Disadvantages n Credit quality n May not be best solution for sophisticated/complex or large risks n Market cycles n When demand exceeds supply, pricing/terms may be unattractive n Limited size of reinsurance market capacity

8 8 Risk Profile and Capital Markets Solutions Objectives n Integrate with other risk management methods, e.g. insurance, mitigation n Capacity (size and new sources) n Cost effective n Credit quality n Stability over time

9 9 Forms of Insurance Securitization n Exchange-traded derivative contracts n Over-the-counter derivatives (swaps) n Catastrophe bonds

10 10 n Key considerations l Exchange volumes: (6/1-10/15 at risk) u u CBOT: $10.8 mm u u BCOE: $12.5 mm l Basis risk l Credit quality l Open price discovery Exchange Traded Derivative Contracts Contracts - Exchange Traded

11 11 Swap Basic Structure Insurance Transformer Premium SwapInsurance Premium Cedent Swap Counterparty Collateral or Guarantee

12 12 Insured Insurance Premiums Insurance Catastrophe Bonds Basic Structure SPV Par Amount Interest Payments Premium at maturity & liquidation Investors Highly Rated Short-term Investments in trust Investors $’s LIBOR Remaining Funds Swap Counterparty LIBOR Investment Income

13 13 Swap vs. Mitsui XL Mid Ocean Issues Credit risk Enforceability More flexible Provides potential leverage for investor More limited investor group Cat Bond USAA Trinity Re Parametric Re Issues Higher cost No credit risk No investor leverage Larger investor group Summary Structures and Issues

14 14 UNL-linked vs. USAA Trinity Re XL Mid Ocean Issues Heavy disclosure Custom hedge Investor concerns Index-linked Parametric SR Earthquake Fund Mitsui Issues Little disclosure Basis risk Indexes Attractive to investors Summary Structures and Issues

15 15 Basis Risk/Transparency Tradeoff Ult. Net Loss Reference Loss Custom Index Standard Index Event Parameter Transparency Basis Risk

16 16 Single year vs. Cost of issuance Expense Time Multi-year Changing exposure profile Reset mechanisms Amortize cost of issuance Lock in price and capacity Summary Structures and Issues

17 17 Capital Markets Solution Recommended Structure n Bond or Swap l large capacity l regulatory issues n High-level attachment l Maximize investor pool l Competes most effectively with insurance n Risk metric: actual loss l Index not appropriate

18 18 Capital Markets Solution Recommended Structure (cont.) n Term: multiple years l Price and capacity stabilized l Transaction costs minimized n Expected loss value for bond held constant l Annual modeled resets l Model version held in escrow at inception l Price stays constant

19 19 Capital Markets Solution Catastrophe Protection Analysis Limits (in millions) 1998 Traditional Cat Reinsurance $650m xs $250m (3 layers) m 912 m 980 m 1.13 b 1.22 b Capital Markets Solution Return Period Year Est Dollar Loss 10 % Co m 50% QS 50% Net Retention Aggregate Catastrophe $65m xs $60m Franchise Deductible - $30m

20 20 Capital Markets Solution Structure highlights (cont.) n Integrated with insurance program l Insurance program designed to change with reset n Co-participation n Issued through an offshore SPV l Tax deductible insurance premium l Funds held in trust l Not issued directly as corporate debt

21 21 Capital Markets Solution Benefits of this Structure n Simple l Maximizes investor interest l Cost n Cost effective l Multi-year amortizes cost over time l Reduced management time

22 22 Securitization General Advantages n High credit quality n Integrates well with insurance structure n Low correlation - attractive investment n Huge potential capacity n No insurance market cycles n Pricing driven by exposure analysis n Intangible benefits

23 23 Securitization General Disadvantages n Untested market – no loyalty n Costs - size constraints n Often complicated structure n Effect of market turmoil? n Statutory accounting and regulatory issues

24 24 Conclusions n No single right answer - a myriad of choices available today that should be explored n Search for the best fit based on your needs, risk appetite and ability to afford reinsurance n Complimentary solution of a mix of traditional reinsurance and risk securitization

25 25 Marsh & McLennan Securities Corp Who we are n An investment bank focused on the insurance industry and insurance related risk transfer products n Primary lines of business l Corporate Finance Advisory l Capital Markets n NASD Licensed Broker - Dealer

26 26 Zurich Financial Services Group Who we are n Zurich Reinsurance (North America) Inc., with $809 million of Statutory Surplus (as of 12/31/97), is the North American Reinsurance arm of Zurich Financial Services, a global financial services company. We are rated “A” by A.M. Best n Within ZRNA, traditional property/casualty reinsurance is written, and through the Centre Re Division we write non-traditional and financial products n ZRNA Treaty Property Division is a leading reinsurer in Property Catastrophe, Specialty Property Lines and weather related products

27 27 This information was prepared by Marsh McLennan Securities Corp. (MMSC) & Zurich Re for use in marketing presentations. It is intended for the exclusive use of the recipients and not for dissemination. Information contained herein is believed to be reliable, but MMSC & Zurich Re do not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. MMSC & Zurich Re may have a business relationship with any of the companies described herein.


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