Insurance Linked Securities Chris Parry Aon Benfield Solutions

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1 Insurance Linked Securities Chris Parry, Aon Benfield Solutions Luca Albertini, Leadenhall Capital Partners Marco Silva, SCOR Charlotte Acton, RMS Insurance Linked Securities Chris Parry Aon Benfield Solutions 1

2 What are Insurance Linked Securities and why are they used? October 17 th 2014 Prepared by Aon Benfield Securities Disclaimer This document or presentation and all of its contents (collectively, the Document ) were intended for general informational purposes only. This Document is intended only for the designated recipient to whom it was originally delivered by Aon Benfield Securities, Inc., Aon Benfield Securities Limited or its affiliates (collectively, Aon ) and any other recipient to whose delivery Aon consents in writing (each, a Recipient ). This Document is strictly confidential and no Recipient shall reproduce this Document (in whole or part) or disclose, provide or make available this Document, or any portion or summary hereof, to any third party without the express written consent of Aon. This Document is made available on an as is basis, and Aon makes no representation or warranty of any kind (whether express or implied), including without limitation in respect of the accuracy, completeness, timeliness, or sufficiency of the Document. This Document is not intended, nor shall it be considered, construed or deemed, as (1) an offer to sell or a solicitation of an offer to buy any security or any other financial product or asset, (2) an offer, solicitation, confirmation or any other basis to engage or effect in any transaction or contract (in respect of a security, financial product or otherwise), or (3) a statement of fact, advice or opinion by Aon or its directors, officers, employees, or representatives (collectively, the Representatives ). Any potential transaction will be made or entered into only through definitive agreements and such other documentation as may be necessary, including, as applicable, any disclosure or offering materials provided by Aon Benfield Securities, Inc. or its appropriately licensed affiliate(s). No representation, warranty or guarantee is made that any transaction can be effected at the values provided or assumed in this Document (or any values similar thereto) or that any transaction would result in the structures or outcomes provided or assumed in this Document (or any structures or outcomes similar thereto). Actual results may differ substantially from those indicated or assumed in this Document. Aon and its Representatives shall have no liability to any party for any claim, loss, damage or liability in any way arising from or relating to the use or review of this Document (including without limitation any actions or inactions, reliance or decisions based upon this Document), any errors in or omissions from this Document, or otherwise in connection with this Document. Aon does not provide and this Document does not constitute any form of legal, accounting, taxation, regulatory, or actuarial advice. 2

3 What is an Insurance-Linked Security ( ILS )? What is an Insurance-Linked Security ( ILS )? Insurance-linked securities (ILS) are broadly defined as financial instruments whose values are driven by insurance loss events. Those such instruments that are linked to property losses due to natural catastrophes represent a unique asset class, the return from which is uncorrelated with that of the general financial market Source: Wikipedia 3

4 Sidecar 28/10/2014 Illustrative Catastrophe Reinsurance Programme ILS Product Range Estimated Collateralised Market Size Retained Risk 250 year Cat Bond 100 year Traditional Limit 60 year ILW $234b $59b $4b $27b $22b $6b Collateralised Re Industry Loss Warranties Catastrophe Bonds 40 year Sidecar 20 year Collateralis ed Re Traditional Reinsurance 15 year Retained Risk Why are ILS products used? Advantages Alternative source of capacity Diverse investor base Capability to absorb large losses Strategic considerations Shareholder friendly Increased competition on reinsurance panel Available for peak zones where reinsurance capacity may be scarce Less exposure to reinsurance pricing cycle Ability to lock-in pricing over multiple years Fully collateralized Higher security valuable, particularly at higher return periods Significantly limited credit risk post event Single shot Disadvantages Fronting reinsurer may offer reinstatements Fixed costs can be larger for single year or smaller issuance sizes Amortised over risk period Basis risk associated with non-indemnity triggers Fronting reinsurer can retain basis risk Time and resources required for structuring and placement 4

5 Capital ($B) 28/10/2014 Alternative Capital Inflows to Reinsurance Market Alternative Capital Growth 150 ILW Sidecar 120 Collateralised Re 90 Cat Bonds Expected Annualised Growth = 25% 60 Annualised Growth = 21% 30 0 $100 billion of alternative capital will enter the reinsurance business over the next five years Reinsurance Market Outlook, Sept Insurance Linked Securities Who invests in ILS and why? Luca Albertini Leadenhall Capital Partners 5

6 Insurance Linked Securities Marco Silva SCOR ILS from the sponsor s point of view October,

7 SCOR Retro team Why do we buy protection? Currently, retrocession is a core strategy Our overall Property reinsurance/ retro spend is in excess of 200M Optimizes capital relief Cost, SII Portfolio Management Provides capital efficiencies Smooth peaks and volatility Capital efficiency, volatility smoother Satisfies regulators, SII Provides us with market intelligence Retro efficiency 7

8 What s our approach to buying protection? We buy Risk and Cat XL Aggregate XL Quota share Cat Bonds Contingent capital across different classes Property R/I Facultative Engineering Marine Motor Decennial Space Diversification is key to SCOR How we see the reinsurance universe 8

9 Global Retro RoL Index (risk-adjusted) Pricing reducing almost back to 2004 levels Provided by Guy Carpenter - strictly private & confidential, not to be distributed Expected Loss multiples reducing More cash to invest, greater modeling transparency, thinner multiples Pricing convergence between traditional markets and nontraditional markets is beginning 9

10 Non-traditional supply continues to grow The alternative capital sector is growing and it is expected to continue to expand SCOR uses alternative capital extensively: o Collateralized (unrated) providers o Cat Bond investors What will the future landscape look like? SCOR has used the non-traditional arena since 1999 We have seen the reinsurance landscape change dramatically Non-traditional sellers see investment opportunities in our market Buyers more comfortable with what non-traditional capacity offers Total capacity estimated to reach $100B by

11 In 2012, rated was almost 70% of the market Rated v Collateralised In 2013, the collateralised markets grew fast to share the market equally with the non-traditional markets This split has stabilized for 2014, due mainly to rated carriers responding with aggressive pricing Provided by AonB - strictly private & confidential, not to be distributed Why choose catastrophe bonds? We use Cat Bonds in conjunction with a traditional placement Cat Bonds model very efficiently in the capital relief / utilisation models Improves efficient frontier (risk/return profile for the same level of risk) 11

12 Cat Bonds in 2014 Mainly indemnity, good for buyer as no basis risk Mainly USA, bit limited for buyer New investor entrants such as the pension fund market is a huge change for the market as their potential capital is so large ($27Tr) compared to a market capacity of around $250B New changes evolving Their ROE demands are low Investment has a long horizon 12

13 More channels to access capacity Excellent capacity diversifier Technical price, lower min RoL Access to huge sums of capacity Positive publicity Buyer s conclusion Capital opportunistic Frictional costs Negative publicity Insurance Linked Securities Charlotte Acton RMS 13

14 WHAT ARE THE RISKS OF ILS AND HOW ARE THEY MODELLED? Capital Markets Solutions Charlotte Acton WHAT ARE THE RISKS? EXPOSED LIMIT ($BN) EXPECTED LOSS? 2014 Risk Management Solutions, Inc. Confidential 14

15 CAT BOND MARKET ($B OUTSTANDING) 2014 Risk Management Solutions, Inc. Confidential WHAT IS STOCHASTIC MODELLING AND WHY IS IT USED? Recent experience 100 years of data 100,000 years of model 2014 Risk Management Solutions, Inc. Confidential 15

16 WE SIMULATE MILLIONS OF HURRICANES 2014 Risk Management Solutions, Inc. Confidential EACH MODELLED EVENT HAS A HAZARD FOOTPRINT 2014 Risk Management Solutions, Inc. Confidential 16

17 Variation 28/10/2014 VULNERABILITY FUNCTIONS LINK HAZARD TO DAMAGE 100% 10% 1.0% 0.1% 0.0% Peak windspeed (mph) Observed Modeled 2014 Risk Management Solutions, Inc. Confidential WHAT ARE THE RISKS? EXPOSED LIMIT ($BN) EXPECTED LOSS 2014 Risk Management Solutions, Inc. Confidential 17

18 BILA wishes to thank Chris Parry of Aon Benfield Solutions Luca Albertini of Leadenhall Capital Partners Marco Silva of SCOR Charlotte Acton of RMS 18