Casualty Actuarial Society: Overview of Catastrophe Risk Securitization

1
Casualty Actuarial SocietyOverview of
Catastrophe RiskSecuritization

• Presented by
• American Re Securities Corporation
• March, 2000

2
Table of Contents

• I. Transaction Structures
• II. Transaction Costs
• III. Transaction Timing
• IV. Catastrophe Bond Investors
• Appendix I Gold Eagle Capital Limited
• Appendix II Other Transactions

This presentation has been prepared by American
Re Securities Corporation on behalf of itself and
associated companies, and is provided for
information purposes only. Under no
circumstances is it to be used or considered as
an offer to sell, or a solicitation of any offer
to buy. Neither American Re Securities
Corporation nor any affiliate has acted or will
act as a fiduciary or financial, investment,
commodity trading or other advisor of or for any
recipient of this presentation and any
investment, trading or hedging decision of a
party will be based upon its own independent
judgement after consultation with such tax,
accounting, legal and other advisors as it deemed
appropriate. Although the information in this
presentation has been obtained from sources
believed to be reliable, we make no
representations as to its accuracy or
completeness and it should not be relied upon as
such. Any opinions expressed herein are subject
to change. From time to time, American Re
Securities Corporation, its associated companies
and any of their officers, employees or directors
may have a position, or otherwise be interested
in, transactions in any securities directly or
indirectly the subject of this presentation.
American Re Securities Corporation, or its
associated companies, may from time to time
perform investment banking or other services for,
or solicit investment banking or other business
from, any company mentioned in this
presentation. The information contained herein
is confidential and may not be copied or
otherwise reproduced or quoted to any party other
than the receiving party (including its
directors, officers, employees, or professional
advisors in whole or in part).
3
Transaction Structures
4
Fundamental Transaction Structure
Investors
Coupon on Principal
Optional
Principal
Premium
Premium
Sponsor
InsuranceIntermediary
Special Purpose Entity
Collateral Trust
Principal
Interest and remaining principal at maturity
Contingent Claims Payment
Contingent Claims Payment

• Insurance Intermediary provides retrocessional
  coverage for Sponsor
• Insurance Intermediary cedes risk to a Special
  Purpose Entity
• The Special Purpose Entity fully collateralizes
  the maximum recovery by issuing securities to
  the Capital Markets

5
Indemnity CAT Bond

• Linked to actual losses of Sponsor in excess of
  retention
• No basis risk
• Co-insurance is required
• Requires extensive disclosure
• Detailed disclosure on underwriting, business
  practices and underlying exposures
• Bond structure must allow for claims development
  period
• Investors have extension risk
• No recovery for Sponsor until the end of the
  development period

Maximum Possible Exposure
Insurer
Indemnity Cat Bond
Investors and Insurer
Actual Losses
Traditional Reinsurance
Re-Insurers and Insurer
Retention
Insurer
6
Parametric CAT Bond

• Linked to physical event parameters
• Location
• Magnitude for Earthquake
• Maximum windspeed or barometric pressure for
  Windstorm (no precedent exists for Windstorm)
• Introduces basis risk between parametric trigger
  and incurred losses
• No Co-insurance
• Requires minimal disclosure
• No disclosure on underwriting, business practices
  or underlying exposures
• No extension risk for Investors
• Less elapsed time before Sponsors recovery than
  for an indemnity bond

Maximum Possible Exposure
Insurer
Parametric Cat Bond
Investors
Magnitude of event
Traditional Reinsurance
Re-Insurers and Insurer
Retention
Insurer
7
Modeled Index CAT Bond

• Modeled Index Linked Securities e.g. ModILSSM
• Linked to an Index
• Modeled Industry Losses
• Modeled Insurer Losses
• Less basis risk than for a Parametric CAT Bond
• No Co-insurance
• Requires minimal disclosure
• No disclosure on underwriting and business
  practices
• If an industry index, no disclosure on Sponsor's
  exposures
• No extension risk for Investors
• Less elapsed time before Sponsors recovery than
  for an indemnity bond

Maximum Possible Exposure
Insurer
ModILSSM Cat Bond
Investors
Modeled Losses
Traditional Reinsurance
Re-Insurers and Insurer
Retention
Insurer
8
Coping with the Basis Differential

• Basis differential can be placed or retained
• The Sponsor can retain the basis
• No cost related to third party taking basis
• Positive value can be structured to equal or
  exceed negative value
• May prevent transaction from being treated as
  reinsurance for regulatory purposes
• Through an Insurance Intermediary, the index or
  parametric bond can be transformed into an
  indemnity policy, and the Intermediary can place
  or retain the basis risk
• An Intermediary can arrange for a cap on the
  basis differential, thereby ensuring performance
  within a collar range

Probability of Exceedance ?
? Loss/Gain ?
0.X
9
Transaction Costs
10
Costs of Transaction

• Initial transaction costs are constant for any
  transaction of 100 million in size or less

• Ongoing transaction costs depend on the maturity
  of the bond. The following estimates are the
  spread to LIBOR demanded by Capital Markets
  investors for a ModILSSM or Parametric bond of BB
  risk

1 Year 3 Year 5 Year 400 bps 450 bps 500 bps
11
Annual Costs of Transaction

• All-in, estimated transaction costs, expressed as
  an annual Rate-on-Line

12
Transaction Timing
13
Time Frame
Indemnity Bond
ModILS SM or Parametric Bond
14
Catastrophe Bond Investors
15
Investors in CAT bonds

• Some Previous Investors
• Bank of Montreal
• Bracebridge
• Capital Research and Trading
• Combined Insurance Company of America
• Everest Re
• John Hancock Mutual Life
• Lazard
• Lincoln Re
• Lutheran Brotherhood
• Pacific Life
• PIMCO
• Renaissance Re
• TIAA
• Travelers
• US Fidelity Guarantee

Mutual Funds
Life Insurers
Hedge Funds
Reinsurers
Banks
Non-Life Insurers
16
Gold Eagle Capital Limited

• Appendix I

17
Transaction Highlights

• Gold Eagle Capital Notes offer diversified
  exposure to catastrophic risk
• East Coast/Gulf Hurricane
• New Madrid Earthquake
• California Earthquake
• Modeled Index Linked Securities (ModILSSM), where
  performance is linked to an index reflecting
  modeled, rather than actual, insurance losses,
  avoid certain risks associated with indemnity CAT
  bonds
• Investors exposed solely to frequency of event
  occurrence, with no uncertainty as to severity of
  loss
• No exposure to claims paying practice or changes
  in underlying policies
• Exposure data and associated attachment points
  are placed in escrow and remain static
• No uncertainty from secondary perils
• Allows rapid post-event settlement period
• Class A Notes were the first, fully
  principal-at-risk, investment grade CAT bond

18
Transaction Summary

• Securities 50 million of Class A Floating Rate
  Modeled Index Linked Notes
• 126.6 million of Class B Floating Rate Modeled
  Index Linked Notes
• Issuer Gold Eagle Capital Limited, a special
  purpose Bermuda company
• Index Swap Counterparty American Re Capital
  Markets, Inc. (ARCM), a wholly owned subsidiary
  of American Re Corporation (ARC)
• Use of Proceeds Invested in Permitted
  Investments to collateralize the Index Swap
• Index Swap
• Calculation Agent Risk Management Solutions,
  Inc. (RMS)
• Maturity Date April, 2001 (subject to a maximum
  extension of 2 months)
• Risk Period November 24, 1999 to March 31, 2001,
  excluding 1999 Hurricane
• Coupon Class A US 3 month LIBOR 295 bps
• Class B US 3 month LIBOR 540 bps
• Ratings Class A Baa3/BBB- Moodys/Fitch
• Class B Ba2/BB Moodys/Fitch

19
Gold Eagle Capital LimitedNovember 1999
CIBC, London
Return on permitted investments
LIBOR -XX
Principal Repayment Interest
Fixed Payment
Index Swap Counterparty (ARCM)
Gold Eagle Capital Limited
ModILSSM Investors
Cash Proceeds
Qualifying Event Settlement Amount
Cash Proceeds from Sale of Notes
Return on Permitted Investments
Collateral Account

• Gold Eagle Capital Limited enters into a
  cash-collateralized, catastrophe Index Swap with
  ARCM.
• Gold Eagle Capital Limited collateralizes this
  swap by issuing 176.6 million of Modeled Index
  Linked Notes to investors.
• Gold Eagle Capital Limited enters into an
  Interest Rate Swap to smooth investment income.

20
Determination of the Index Value

• RMS determines if a given Hurricane or Earthquake
  is a Qualifying Event.
• Within 60 days
• RMS parameterizes (quantifies the characteristics
  of) the Qualifying Event
• RMS calculates an Index Value utilizing those
  parameters and the escrowed Exposure Dataset
• If the final Index Value results in a write down
  of principal, such write down will occur on the
  Interest Payment Date following the determination
  of the Index Value
• Any Index Value resulting in a principal
  write-down must be supported by an Agreed Upon
  Procedures Letter from KPMG to verify the correct
  application of the RMS model
• Generic event and write-down timing example

January, 2001 Interest Payment Date write-down of
principal
September, 2000 Trigger Event
November, 2000 60 day final Index Value
30 days
5 days
variable
30 days
January, 2001 Determination Date gt60 days after
event
October, 2000 30 day Preliminary Index Value
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Modeled Risk Profile
Class A Notes Attachment Probability (17
month) 0.24 Exhaustion Probability (17 month)
0.24 Expected Loss (17 month) 0.24 Expected
Loss (annualized) 0.17 Class B
Notes Attachment Probability (17 month)
1.10 Exhaustion Probability (17 month)
0.70 Expected Loss (17 month) 0.89 Expected
Loss (annualized) 0.63
Principal Reduction
17 month Exceedance Probability
Class A
177 million
0.24
Entire Class B
127 million
0.70

• Events Qualifying for Calculation
• A Hurricane of category 1 or higher, occurring in
  the Eastern Hurricane Region on or after January
  1, 2000
• An Earthquake in the New Madrid Seismic Zone or
  California exceeding magnitude 5.0 at its
  epicenter

2/3 Class B
84 million
0.86
1/3 Class B
42 million
1.10
22
New Madrid Modeled Risk Profile
RMS CAT Index Value
17 month Exceedance Probability
Boundaries for Qualifying New Madrid Earthquake
Events
Class A
620
0.11
Entire Class B
470
0.18
2/3 Class B
435
0.22

• Events Qualifying for Calculation
• An Earthquake exceeding certain magnitude
  thresholds at its epicenter, in the New Madrid
  Region
• Mw Mb Ms
• 5.0 5.0 5.0

1/3 Class B
400
0.24
23
California Modeled Risk Profile
Boundaries for Qualifying California Earthquake
Events
RMS CAT Index Value
17 month Exceedance Probability
Class A
620
lt0.03
Entire Class B
291
lt0.03
2/3 Class B
260
0.05

• Events Qualifying for Calculation
• An Earthquake exceeding certain magnitude
  thresholds at its epicenter, in the California
  Region
• Mw Mb Ms
• 5.0 5.0 5.0

1/3 Class B
245
0.17
24
East Coast/Gulf Modeled Risk Profile
RMS CAT Index Value
15 month Exceedance Probability
Boundaries for Qualifying Hurricane Events
Class A
620
0.11
Entire Class B
410
0.49
2/3 Class B
395
0.59

• Events Qualifying for Calculation
• A Hurricane occurring in the Eastern Hurricane
  Region of category 1 or higher. Any named
  tropical storm or hurricane that is designated as
  such by the NHC prior to January 1, 2000 shall be
  excluded as a Qualifying Event.

1/3 Class B
380
0.70
25
Historical Events
26
Other Transactions

• Appendix II

27
Some Comparable Transactions