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An Overview of Cat Bond:    Theory and Practice1
Introduction     The market for insurance risk transfer to the debt capital       markets started after Hurricane Andrew ...
Outline    • Cat Bond Basics       – Securitization Review       – Bond structure       – Case Study    • Market Dynamics ...
Cat Bond Basics:    1. Securitization Review    • Securitization:       – Packaging and selling of loans and other assets ...
Cat Bond Basics:              1. Securitization Review              • Insurance-linked Securities:                  – Tran...
Cat Bond Basics:                  2. Bond Structure                                                                       ...
Cat Bond Basics:                     2. Bond Structure                     • Trigger System:Basis Risk is the       – Tran...
Cat Bonds Basics:    2. Bond Structure       New Opportunity    • Sponsors Perception ( compared with reinsurance)       –...
Cat Bonds Basics:                       3. Case Study: Blue Wings LtdBlue Wings is theUSD1bn multi-peril                  ...
Cat Bonds Basics:                         3. Case Study: Blue Wing LtdThis innovative          Class/Series:              ...
Outline     • Cat Bonds Basics:        – Securitization Review        – Bond structure        – Case Study     • Market Dy...
Market Dynamics                     • Hannover Re issued the first cat bond in 1994                     • In 1997, there e...
Market Dynamics     from 1997 to 2004(pre-Katrina period)     • From 1997 to 2004, CatBond Market developed slowly       w...
Market Dynamics     from 1997 to 2004(pre-Katrina period)     • Yearly new issued CatBond value        2000        1800   ...
Market Dynamics:     Katrina Hurricane     • Date: 24-30 Aug, 2005     • Country/place: US, Gulf of Mexico, Bahamas, North...
Market Dynamics:                     aftermath of Katrina Hurricane(1)KAMP Reprotects ZurichAmerican             • The fir...
Market Dynamics:     aftermath of Katrina Hurricane(1)17     Source: Guy Carpenter
Market Dynamics:     aftermath of Katrina Hurricane(2)     • A dramatic rise in the cost of reinsurance for companies     ...
Market Dynamics:     aftermath of Katrina Hurricane(2)       Source: Guy Carpenter19
Market Dynamics:     from 2006 to 2007(post-Katrina Period)     • From 2006, CatBond began to develop rapidly        – Yea...
Market Dynamics:                from 2006 to 2007(post-Katrina Period)                • Shelf-offering become more and mor...
Market Dynamics:     from 2008 to present     • From 2008, influenced by Financial Crisis, CatBond       suffered slow dev...
Market Dynamics:     from 2008 to present     • The severe impact of the Lehman Brothers default on       Cat Bonds       ...
Market Dynamics:     from 2008 to present     • The market has now changed and future issuance will       be more transpar...
Outline     • Cat Bonds Basics:        – Securitization Review        – Bond structure        – Case Study     • Market Dy...
Prospect in China:     1. Urgency     • (1)Frequent natural disaster     • (2)Limited underwriting capacity of property   ...
Prospect in China:     1. Urgency     • Increase underwriting capacity of domestic       insurance industry     • Reduce g...
Prospect in China:     2. Challenges      (1)Market challenges of issuing CatBond     • Demand side:lack of institutional ...
Prospect in China:      2. Challenges     • (2)Technical challenges of issuing CatBond     • Catastrophe indexes system巨灾指...
Prospect in China:     2. Challenges     • (3)Regulation challenges of issuing CatBond     • Missing relevant regulation  ...
Prospect in China:     3. Suggestions     • (1)Construct Catastrophe risk indexes system,       improve catastrophe pricin...
Prospect in China:      3. Suggestions     • (3) Develop Capital Market       —investment banking and evaluation intermedi...
Prospect in China:     3. Suggestions     • Government Leading Mode(Non-business)        – Practice in Taiwan     • Overse...
Prospect in China:     3. Suggestions34
Prospect in China:     3. Suggestions35
References (参考文献)     • Guy Carpenter:        –   Cat bond at the year-end 2002        –   Cat bond at the year-end 2003  ...
Questions & Answers37
38
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An overview of cat bond

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  1. 1. An Overview of Cat Bond: Theory and Practice1
  2. 2. Introduction  The market for insurance risk transfer to the debt capital markets started after Hurricane Andrew and the Northridge Earthquake in the 1990s and has grown into an important catastrophe risk management tool  Cat bonds offer an alternative capacity source for natural catastrophe insurance  Investor interest continues to grow due to attractive yields and increased understanding of natural catastrophe risk  Since 1997,when the market began in earnest, by July 2009, 141 cat bonds have been issued, with total risk limits of USD27bn.  Cat bonds and other ILS products may in the future prove to be useful risk management tools here in China and elsewhere in Asia2
  3. 3. Outline • Cat Bond Basics – Securitization Review – Bond structure – Case Study • Market Dynamics – From 1997 to 2004 – From 2005 to 2007 – From 2008 to present • Prospect in China – Urgency – Challenges – Suggestions3
  4. 4. Cat Bond Basics: 1. Securitization Review • Securitization: – Packaging and selling of loans and other assets backed by securities – Result of securitization is ABS(Asset Backed Security) – Investors bear return and risks • Examples: – XYZ Bank loans 10 people $100,000 a piece – Put them in a pool and sell this pool to a larger entity, ABC. – ABC will then split this pool into equal pieces. – The pieces will then be sold to other smaller investors (as bonds).4
  5. 5. Cat Bond Basics: 1. Securitization Review • Insurance-linked Securities: – Transfer insurance-related risks to capital market • category: Non-life Life Mass Risk Protection Financing tool by turning Non-Cat future income into capital Motor Insurance Securitization Embedded value securitization Regulatory capital Our maintopic today Protection for extreme Extreme risk transfer Cat events Hurricane and earthquake cat Mortality bond bonds Longevity bond( first trial failed)5
  6. 6. Cat Bond Basics: 2. Bond Structure Other entities • Cat Bond involved: Risk Modeling – Transfer catastrophe risk to capital market Firm;Total Return InvestmentSwap Bank;is a financial Investments ③ Rating Agencycontract Bond Insurer;which proceeds principle principle ② .transfers both ① premiumthe credit risk Sponsor SPV Coupon Investorsand market (Cedant) (Issuer) Contingentrisk of an payment principleunderlying Agreed proceedsasset. rate Loss ④ Reporting Swap counterparty Agency 6
  7. 7. Cat Bond Basics: 2. Bond Structure • Trigger System:Basis Risk is the – Transparency directly influence the issuer’s Basis Risk, higherrisk that, in the transparency leads to greater Basis Riskevent of a coveredloss, the payout • Sort:determined by – indemnity-basedthe bondcalculation will – index-baseddiffer from the • parametric trigger:ShakeMap (US) for earthquakes; AMeDAS ( Japan )actual loss for typhoonincurred by the • industry loss trigger:PCS( property claim services); Sigma; PERILS ( Pan-sponsor. European Risk Insurance Linked Services); NatCatSERVICE • modeled loss trigger) – hybrid trigger • Two-peril transaction, US hurricane and Japanese earthquake perils 7
  8. 8. Cat Bonds Basics: 2. Bond Structure New Opportunity • Sponsors Perception ( compared with reinsurance) – Risk transferred are usually 100- 250 years – Collateral guarantee for extreme event – Lock risks with year-to-year constant price • Investors Perception – Less correlation with other assets return – Good hedging instrument8
  9. 9. Cat Bonds Basics: 3. Case Study: Blue Wings LtdBlue Wings is theUSD1bn multi-peril • Sponsor: Allianz Global Corporate & Specialty AGshelf program Blue Wings Ltd., a special purposesponsored by • Issuer: Cayman Islands exempted companyAllianz Global Swiss Reinsurance CompanyCorporate & • Intermediary: On or after the Initial Issuance Date, theSpecialty AG (AGCS),and intermediated • Program design: Issuer may from time to time issue one orby Swiss Re more Class(es) of Notes in distinct Series pursuant to this USD1bn Program Reinsurance Contract(s) Allianz Global SwissDefinition of Corporate & Reinsurance Specialty CompanyShelf Offering Premium Financial Contract(s) Premium Investment Income Proceeds Blue Wings Ltd SwapCounter- Swap Counterparty party Coupon: LIBOR + spread Investors Issuer collateral LIBOR - spread & payment Return of Outstanding + Investment Losses Amount at Maturity 9 account
  10. 10. Cat Bonds Basics: 3. Case Study: Blue Wing LtdThis innovative Class/Series: Class A, Series 1transaction marksan important step Principal Amount: USD 150 millionof the ILS market Covered Perils: A combination of Canada and US earthquake,as it is the first cat excluding California (“EQ”), & Great Britain riverbond with risk flood (“FL”)based on riverflood Trigger: Modeled Loss for EQ & Parametric Index for FL Sole Arranger and Lead Manager: Swiss Re Capital Markets Modeling Firm/Calculation Agent: Risk Management Solutions (“RMS”) Flood Measurement Agent: Halcrow Group Limited (“Halcrow”) Expected Loss: 0.54% (Annualized, 0.43% EQ; 0.11% FL) Risk Period: April 4, 2007 to December 31, 2011 Maturity: January 10, 2012 Rating: BB+ (S&P) Price: 3M LIBOR + 315 bps 10
  11. 11. Outline • Cat Bonds Basics: – Securitization Review – Bond structure – Case Study • Market Dynamics – From 1997 to 2004 – From 2005 to 2007 – From 2008 to present • Prospect in China – Urgency – Challenges – Suggestions11
  12. 12. Market Dynamics • Hannover Re issued the first cat bond in 1994 • In 1997, there existed five cat bond transactions which marks the beginning of the Cat Bond MarketFrom 1997 to 2004 30 27 25From 2005 to 2007 20 20From 2008 to Pres. 18 15 13 10 10 10 9 8 7 7 7 6 5 5 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 12 Source: Guy Carpenter 发行数量
  13. 13. Market Dynamics from 1997 to 2004(pre-Katrina period) • From 1997 to 2004, CatBond Market developed slowly with small amount of transaction and volume 12 10 10 9 8 8 7 7 7 6 6 5 4 2 0 1997 1998 1999 2000 2001 2002 2003 2004 发行数量13 Source: Guy Carpenter
  14. 14. Market Dynamics from 1997 to 2004(pre-Katrina period) • Yearly new issued CatBond value 2000 1800 1729.8 1600 1400 1200 1219.5 1139 1142.8 1000 984.8 966.9 800 846.1 600 633 400 200 0 1997 1998 1999 2000 2001 2002 2003 2004 Source: Guy Carpenter 新发行债券额 • Reason – Investors’ uncertainty about new instrument – Complex design and high issuing cost – Other substitutes such as catastrophe insurance14
  15. 15. Market Dynamics: Katrina Hurricane • Date: 24-30 Aug, 2005 • Country/place: US, Gulf of Mexico, Bahamas, North Atlantic, LA, MS, AL, FL, TN, New Orleans, Biloxi, Mississippi, Mobile, Gulfport • Event: with winds up to 224km/h, Mississippi banks burst, New Orleans flooded, severe damage to oil rigs • Casualty: 1326 dead;75,000 homeless; $45bn insured loss; $135bn total damage15 Source: Swiss Re sigma2006
  16. 16. Market Dynamics: aftermath of Katrina Hurricane(1)KAMP Reprotects ZurichAmerican • The first publicly disclosed total loss to a catastropheInsurance bond in KAMP Re 2005 .Corporationagainst U.S. • Rating agencies to revise their capital requirementshurricanes for upward for insurers and reinsurers with catastrophethree years and exposuresalso againstquakes on the • Risk modeling firms to announce their intention toNew Madrid revise their modelsfault. The bondwill be triggered • Because of these reasons, with the exception of oneif Zurichs losses offering, all 2005 transactions brought to market post-from a singlestorm or quake Katrina settled at yields considerably above comparablerise above 2004 issues$1bn. 16
  17. 17. Market Dynamics: aftermath of Katrina Hurricane(1)17 Source: Guy Carpenter
  18. 18. Market Dynamics: aftermath of Katrina Hurricane(2) • A dramatic rise in the cost of reinsurance for companies that had suffered catastrophe losses • A substantial increase in the degree of uncertainty concerning renewal pricing and capacity available from traditional reinsurance writers of catastrophe lines • The placement of a significant quantity of cat bonds in a short period of time to mitigate impending rating agency concerns and secure fully collateralized capacity18
  19. 19. Market Dynamics: aftermath of Katrina Hurricane(2) Source: Guy Carpenter19
  20. 20. Market Dynamics: from 2006 to 2007(post-Katrina Period) • From 2006, CatBond began to develop rapidly – Yearly new issued amount of bonds 30 25 20 15 10 5 0 2005 2006 2007 发行数量 – Yearly new issued value of bonds 8000 6996.3 6000 4693.4 4000 2000 1991.1 0 2005 2006 200720 新发行债权额
  21. 21. Market Dynamics: from 2006 to 2007(post-Katrina Period) • Shelf-offering become more and more popular – This reflects that Cat Bond purchases shift from tactical to strategicSource:Guy Carpenter 21
  22. 22. Market Dynamics: from 2008 to present • From 2008, influenced by Financial Crisis, CatBond suffered slow development. Only 14 bonds were issued in 2008, which is greatly below the level of 2007 30 25 20 15 10 5 0 2006 2007 2008 发行数量22
  23. 23. Market Dynamics: from 2008 to present • The severe impact of the Lehman Brothers default on Cat Bonds – Lehman was the TRS counterparty to the collateral accounts for four Cat Bonds – The failure of Lehman left investments in these accounts without protection – The ratings of the four transactions were subsequently lowered and prices declined – By the end of July 2009, two of the four bonds had gone into default23
  24. 24. Market Dynamics: from 2008 to present • The market has now changed and future issuance will be more transparent – Enhanced transparency with regard to the investments held in the collateral trust – Tighter investment restriction for the collateral account regarding quality, liquidity – More frequent mark-to-market of the collateral with the TRS counterparty required to post any shortfalls to the collateral account – Alternatives to traditional TRS structure such as posting the collateral in a bank deposit24
  25. 25. Outline • Cat Bonds Basics: – Securitization Review – Bond structure – Case Study • Market Dynamics – From 1997 to 2004 – From 2005 to 2007 – From 2008 to present • Prospect in China – Urgency – Challenges – Suggestions25
  26. 26. Prospect in China: 1. Urgency • (1)Frequent natural disaster • (2)Limited underwriting capacity of property insurance company and reinsurance company26
  27. 27. Prospect in China: 1. Urgency • Increase underwriting capacity of domestic insurance industry • Reduce government burden, establish long-term catastrophe compensate system • Develop capital market27
  28. 28. Prospect in China: 2. Challenges (1)Market challenges of issuing CatBond • Demand side:lack of institutional investors • Supply side: non-market operation of catastrophe risks28
  29. 29. Prospect in China: 2. Challenges • (2)Technical challenges of issuing CatBond • Catastrophe indexes system巨灾指数体系 • Credit rating system信用评级体系 • Investment banking 投资银行等证券承销机构 • Risk modeling company风险模型公司29
  30. 30. Prospect in China: 2. Challenges • (3)Regulation challenges of issuing CatBond • Missing relevant regulation • Limitation of separate regulation between insurance industry and security industry30
  31. 31. Prospect in China: 3. Suggestions • (1)Construct Catastrophe risk indexes system, improve catastrophe pricing abiluty —integrate catastrophe database —country index, region index, province index —establish simulate model of China catastrophe • (2)Completed credit rating system31
  32. 32. Prospect in China: 3. Suggestions • (3) Develop Capital Market —investment banking and evaluation intermediary —Information revealing Insurance company issuing CatBond should report operation and financial status32
  33. 33. Prospect in China: 3. Suggestions • Government Leading Mode(Non-business) – Practice in Taiwan • Oversea Reinsurance Company Leading Mode(Business)33
  34. 34. Prospect in China: 3. Suggestions34
  35. 35. Prospect in China: 3. Suggestions35
  36. 36. References (参考文献) • Guy Carpenter: – Cat bond at the year-end 2002 – Cat bond at the year-end 2003 – Cat bond at the year-end 2004 – Cat bond at the year-end 2005 – Cat bond at the year-end 2006 – Cat bond at the year-end 2007 • Swiss Re: – Sigma No.4/2009, the role of indices in transferring insurance risk to capital market – Sigma No.7/2006, Securitization: new opportunities for insurers and investors36
  37. 37. Questions & Answers37
  38. 38. 38

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