11 35am schmutz, markus


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11 35am schmutz, markus

  1. 1. Alternative Risk Transfer Mechanisms Presentation to: The Annual Insurance Executive Conference Markus Schmutz Swiss Re Capital Markets December 2013 1 Proprietary and Exclusive
  2. 2. What are Insurance Linked Securities?  Natural catastrophe bonds (cat bonds for short) and other types of ILS are usually issued in order to provide re-/insurance protection to insurers, reinsurers, governments, and corporations  Cat bonds allow companies to obtain reinsurance protection from a new pool of capital separate from traditional reinsurers – Money managers, hedge funds, and pension funds represent a new pool of capital for insurers and reinsurers to gain protection from  Investor capital provides collateralized cover – Investor capital sits in a segregated collateral account, meaning that if an event occurs, dedicated funds are available to make a payment – This virtually eliminates the credit risk inherent in traditional re-/insurance 2 Proprietary and Exclusive
  3. 3. How do Cat Bonds work? 1 Risk Transfer Contract Sponsor 2 SPV Note Proceeds Coupon: DIY + [ ]% Premium Collateral . Trust Investments Investors Return of Remaining Principal Directed Investments Yield 3 Stable Value Investments 1. The sponsor (the insurer or reinsurer looking to get protection) enters into a risk transfer contract (reinsurance or derivative) with a special purpose company established specifically for the transaction (SPV) 2. The SPV capitalizes itself by issuing Notes (the "Cat Bonds") to Investors in the capital markets in an amount equal to the limit of the risk transfer contract 3. Proceeds from the securities offering are transferred into a collateral trust account and invested to provide a stable return 4. If no covered event occurs during the risk period the bonds will be redeemed at 100% of face value. In case of a covered event meeting the thresholds set forth in the risk transfer contract, funds will be withdrawn from the collateral account to make an event payment to the sponsor. The redemption price of the bonds is reduced accordingly 3 Proprietary and Exclusive
  4. 4. How ILS emerged  In 1992, Hurricane Andrew made landfall in Florida causing $15.5b in insured losses  The resulting shortage of reinsurance capacity prompted reinsurers, banks, and academics to investigate new ways of transferring catastrophe risk outside the traditional reinsurance capital pool  In 1997, Residential Re, the first catastrophe bond was sold to capital markets investors, protecting USAA against the risk of a major hurricane  Since then, approximately $54 billion of cat bonds have been issued, providing protection to over 80 insurers, reinsurers, governments, and corporations for a multitude of risks 4 Proprietary and Exclusive
  5. 5. ILS Universe Non-Life Life  Catastrophe Bonds  Catastrophe Derivatives/ Industry Loss Warranties  Collateralized reinsurance/retro  Quota Shares/Sidecars  Currently $19.8 billion in cat bonds are outstanding, with an estimated $28 billion in other private non-life risk transfer to capital markets investors Swiss Re has issued approximately $2.2 billion in Vita extreme mortality bonds since 2003. Extreme Mortality Bonds  Longevity swaps/bonds  Embedded Value Securitizations  Life Settlement Securitizations  Reserve Financing (e.g. Reg XXX) Post financial crisis, the embedded value and life settlement markets have slowed considerably 5 Proprietary and Exclusive
  6. 6. Global cat bond market reaches all time high Cat bond issuance and outstanding (USD bn)  2013 will become the second 19.8 18 17.0 16.5 14.9 14.0 14 13.7 13.2 8.8 12 10.2 10.1 10 $bn  28 deals YTD, pushing total volume 15.7 16 12.7 9.0 11.4 8 taking advantage of low spreads and structural innovations 6.4 4.6 4 1.9 2 0 0.7 0.9 0.2 0.7 1.0 0.2 0.8 2.4 2.8 0.8 1.4 1.0 1.0 4.6 3.9 3.5 1.8 1.1 2.2 2.4 8.2 5.7 2.5 5.0 3.0 3.5 6.3 6.5 4.6 1.1 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Issued outstanding to approximately USD 20bn, largest year end total on record  Repeat sponsors driving growth, 9.1 4.4 6 largest issuance year in history Outstanding from previous years  Since 2011, outstanding Cat Bond market has grown by approx. USD 6bn with new sponsors accounting for USD 2bn of the growth  Investor demand continues to outweigh supply Source: Swiss Re Capital Markets; 2013 new issuance volume is second largest ever; market grew by around 20% Y/Y 6 Proprietary and Exclusive
  7. 7. Cat bond market delivered a steady stream of uncorrelated returns Cat high yield performance January 2002 – November 2013 2.40 2002-2013 (YTD) 0.90 S&P 500 Total Return 8.43% 5.63% 8.56% 6.58% 18.23% 2.60% Jul-13 Jul-12 Jan-13 Jul-11 Jan-12 Jul-10 Jan-11 Jul-09 Jan-10 Jul-08 Jan-09 Jul-07 Jan-08 Jul-06 Jan-07 Jan-06 Jul-05 Jul-04 Barclays Ba US High Yield Jan-05 Jul-03 Jan-04 Jul-02 Jan-03 Jan-02 0.40 Global Cat Bond Index Annualized Weekly Volatility 1.40 S&P500 Total Return Annualized Return 1.90 Barclays US High Yield Swiss Re Global Cat Bond Index Total Return Source: Swiss Re Capital Markets;  Cat bond market proved resilient despite financial market turmoil and natural catastrophes  5 bonds have been triggered by catastrophes(1) of the roughly 230 bonds issued (440 classes) since 2002, causing a total loss of USD 650m compared to USD 7.5bn of spread payments over the observed period (1) 4 additional bonds lost some principal as a result of the Lehman Brothers default Majority of cat bonds are structured for very large catastrophes which, fortuitously, did not occur 7 Proprietary and Exclusive
  8. 8. Catastrophe Bond Capacity Deployed Peril Overview for Outstanding Bonds  The ILS Market is heavily weighted towards U.S. Hurricane:  Two thirds of the outstanding notional is exposed to U.S. Hurricane Events  Sponsors would see significant pricing difference between U.S. Hurricane and non-peak perils, as investors have strong demand for non-peaks Outstanding Cat Bonds by Peril Percent Exposed to Peril 70% 60% 50% 40% 30% 20% 10% 65% US Wind 53% 50% US EQ 44% 44% Non Peak 38% 28% 15% 19% 10% 8% 5% 5% 3% 2% 0% 2% 2% 1% 0% Source: Swiss Re Capital Markets. As of December 3, 2013 with percentages calculated based on notional amount 8 Proprietary and Exclusive
  9. 9. Increased demand from investors pushed cat bond spreads to new lows Illustrative primary issuance spread (US Wind) 1 Spreads for U.S. wind exposed bonds are down by 40% y/y, while non-U.S. spreads decreased by approximately 35%  Non-U.S. wind risk continues to price at tighter levels as investors seek diversifying risk spread  2013 primary issuance spread 1200 spread 1000 800 600 400 200 0 0 50 100 150 US Wind 200 250 300 350 400 expected loss Non-US Wind 9 (1) Swiss Re Capital Markets pricing indications only; estimated primary issuance spread computed for an expected loss of 2% using regression analysis Proprietary and Exclusive
  10. 10. Spread tightening is slowing, indicating that the market may have found a new price baseline Cat Bonds secondary market spreads Historical Average Seasonally Adjusted Spreads 1 (Cat Bonds Secondary Market)  High yields, along with benefits of diversification are the major factors attracting investors to cat risks  Some investors have hinted they would potentially consider slowing down their commitment to the asset class should spreads drop any further  Spreads for top layers have been fairly stable over recent months. However, short term variability for lower layers is expected 15% 12% 12% 9% 9% 6% 6% 3% 3% 2007 0% 2009 2011 2013 Data source: SRCM. Seasonally adjusted secondary market spreads for a subset of bonds that have a rating between B-/B3 and BB+/Ba1, a stated expected loss between 1.25-2.5% and are exposed predominantly to U.S. peak perils 1 10 Proprietary and Exclusive
  11. 11. Shift from short term oriented to long term oriented investors Typical investor breakdown by type 2013 3.1% 0.7% 0.3%  Pension funds through dedicated cat bond funds, 13.0% mutual funds, institutional money managers are increasingly investing in cat bonds Dedicated Money Manager Reinsurer  The relative share of short term oriented hedge funds has decreased Hedge fund 25.3% 57.7% Insurer Pension Fund Cat Bond Trigger Breakdown (2009-2013)  While the investor base has broadened, dedicated cat bond funds remain the dominant category  Investors are increasingly comfortable with indemnity bonds and complex structures  50% of bonds issued in 2013 have an indemnity trigger  Cat Bonds expanded from providing "top-of-thetower" cover with a remote ~1% Expected Loss towards the "working layers". A recent transaction featured an EL above 10% 11 Source: Swiss Re Capital Markets Proprietary and Exclusive
  12. 12. Alternative capital is (re-)gaining market shares Estimated size of global market [bn USD]  Dedicated cat funds are crowded out into collateralized reinsurance  Collateralized reinsurance grows fastest, reaching the volume of cat bond market  Indemnity capacity becomes widely accepted. ILW market shrinks significantly  Some sidecars are scaled back as a result of market softening  45 Alternative capital grew sharply since 2011 to USD 45 bn  50 Alternative capital market share accounts for approximately 11% globally and about 17% in the U.S., exceeding the 2007 level (post-Katrina) 40 35 30 25 20 15 10 5 0 2005 2006 2007 Sidecar 2008 ILW 2009 2010 Collateralized RI 2011 2012 ILS 2013 Estimated market share (excl. Retro capacity) 12 Source: Swiss Re Capital Markets Proprietary and Exclusive
  13. 13. Alternative capital is largely focused on peak risks Distribution by segment and peril  33%  Alternative capital struggles to expand outside the U.S., due to: Backing reinsurers Backing insurers 67% Alternative capital plays a significant role in the U.S. Nat Cat and retro market, characterized by low entry barriers and still relatively high margins – 5% US cat 25% European cat Other 70% Ample traditional reinsurance capacity – Reinsurers offer traditional reinsurance at very competitive rates, leveraging their capital multiple times – Lack of market loss indices – Less reliable risk modeling – Cannot offer reinstatements Source: Swiss Re Capital Markets 13 Proprietary and Exclusive
  14. 14. Demand for Nat Cat capacity will continue to increase Nat Cat Demand Dynamic  Demand for Nat Cat will further increase, on average by approx. 50% in mature markets and 100% in High Growth Markets by 2020 – Growing middle class in High Growth Markets (HGM) leading to higher insurance penetration –  Growth in exposed economic values – Increase in largest industry loss scenarios (2012 vs. 2020) Governments moving Nat Cat risks into the private sector Alternative capital is expected to grow in the U.S. at least at the same pace and may gain further market shares EQ: Earthquake (500 yrs) TC/WS: Tropical Cyclones/Winter Storms (100 yrs); TC includes storm surge FL: River Flood (250 yrs) Source: Swiss Re 14 Proprietary and Exclusive
  15. 15. Conclusion  Low interest rates combined with financial market uncertainties will persist and will foster further capital inflows into the alternative capital market – –  Capital inflows will keep the demand for cat bonds high and spreads tight Some sidecars are scaled back as the result of market softening Alternative capital (including cat bonds) is likely to gain further market shares but will remain a complementary product in the global (re-)insurance market – Growth of alternative capital markets products is largely confined to peak risks – Reinsurance remains very efficient  The staying power of capital markets investors has yet to be tested in case of a rise in interest rates, decreasing Nat Cat returns or large catastrophe losses  Alternative capital increases competition and capacity, but large, diversified reinsurers will be less impacted 15 Proprietary and Exclusive
  16. 16. Risk Factors * An investment in Insurance Linked Securities involves potentially significant risks for an investor. In summary, these risks include (but are not limited to): •Investors may lose all or a portion of their investment in Insurance Linked Securities if a natural catastrophe or other event triggers a payment by the issuer of the Insurance Linked Securities under the underlying risk-transfer agreement that the Insurance Linked Securities relate to. •The maturity of Insurance Linked Securities may be extended without the prior consent of the investor. •The Insurance Linked Securities may be redeemed before their maturity date (including before any extension of such maturity date by the issuer). •If the Insurance Linked Securities are redeemed before maturity, the interest rate payable under the Insurance Linked Securities will be reduced. •Investors have limited recourse to assets of the issuer of the Insurance Linked Securities and no recourse to assets of the counterparties to the underlying risk-transfer agreements to which the Insurance Linked Securities relate. •If the issuer of the Insurance Linked Securities becomes insolvent, investors may lose some or all of their investment. •Investors may be required to consolidate the issuer for accounting purposes under certain circumstances. •An investment in the Insurance Linked Securities may have adverse tax consequences for investors. •Any claim you have against the issuer in the event of the issuer's insolvency will rank below any claim a counterparty to the underlying risktransfer agreements, to which the Insurance Linked Securities relate, has against the issuer. •Enforcement of the security interest granted to a Trustee for the benefit of the investors may be limited. •The Insurance Linked Securities may not have a secondary market or the secondary market for the Insurance Linked Securities may have limited liquidity; the market price of the Insurance Linked Securities in the secondary market may be highly volatile. •The Rating Agenc(y)(ies) (if any) may change any rating assigned to the Insurance Linked Securities. Any credit rating given in respect of the Insurance Linked Securities may not reflect the potential impact of all risks related to the Insurance Linked Securities. A credit rating is not a recommendation to buy, sell or hold the Insurance Linked Securities and may be revised or withdrawn by the rating agency at any time. The risk factors relating to an investment in Insurance Linked Securities are set out in detail in the offering materials for the relevant Insurance Linked Securities. Before entering into any financial transaction, you should ensure that you fully understand the terms, have evaluated the risks and determined that the transaction is appropriate for you in all respects. 16 Proprietary and Exclusive
  17. 17. Disclaimer Swiss Re Capital Markets Corporation is a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”), and is regulated by the FINRA. This document is solely for your use (“you”). The concepts and structures it contains are confidential and proprietary information, as well as business assets of Swiss Re Capital Markets Corporation and our affiliates (“SRCM”, “us” or “we”). They are shared with you for the exclusive purpose of allowing you to evaluate your interest in such structures. In particular, this information may not be used to discuss similar structures with any person SRCM could reasonably consider a competitor in this field. Unless otherwise agreed in writing, SRCM and its affiliates act solely in the capacity of an arm's length contractual counterparty and not as an adviser or fiduciary. Accordingly, you should not regard transaction proposals or other written or oral communications from us as a recommendation or advice that a transaction is appropriate for you or meets your financial objectives. Any financial transaction involves a variety of potentially significant risks and issues. Before entering into any financial transaction, you should ensure that you fully understand the terms, have evaluated the risks and determined that the transaction is appropriate for you in all respects. If you believe that you need assistance, you should consult appropriate advisers before entering into the transaction. SRCM does not provide accounting, tax or legal advice. In addition, we agree that, subject to applicable law, you may disclose any and all aspects of any potential transaction or structure described herein that are necessary to support any U.S. federal income tax benefits, without SRCM imposing limitation of any kind. This material does not constitute an offer to enter into any transaction. Such material is believed by us to be reliable, but we make no representation as to its accuracy or completeness. This brief statement does not purport to describe all of the risks associated with financial transactions and should not be construed as advice to you. Certain aspects of this presentation may give rise to perceived or actual conflicts of interest (i) between you and us and/or (ii) among you, us and other third parties. Such conflicts may arise from other business activities customarily conducted by other areas of our firm with you or with other clients. Such activities may include, but are not limited to, sales and trading activities. For example, we may already have executed similar transactions or strategies for our own account or accounts of other clients and we may have made similar presentations to others. Execution of any transaction contemplated in this presentation may involve other affiliates of SRCM and may result in perceived or actual self-dealing intended to generate revenue for our firm. This document is for information purposes only and does not constitute an invitation or inducement or an offer or commitment, a solicitation of an offer or commitment, or any advice or recommendation, to conclude any transaction. While information herein has been obtained from sources believed to be reliable, we do not represent it to be accurate or complete. The information contained herein includes illustrations, estimates and projections and involves significant elements of subjective judgment, assumptions and analysis. Any views or opinions (including illustrations, estimates, statements or forecasts) constitute our judgment as of the date indicated and are subject to change without notice. No representation is made as to the accuracy of such illustrations, estimates or projections or that all assumptions relating to them have been considered or stated or that such projections or returns will be realised. The returns or performance results may be lower than estimated herein. Note that past performance is not indicative of future results. The information contained herein does not purport to contain all of the information that may be required to evaluate such solutions and you are encouraged to conduct independent analysis of the data referred to herein. We do not undertake to update this document. 17 Proprietary and Exclusive
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