1 Presentation to: Presentation to: The CAS Seminar on The CAS Seminar on Financial Risk Management Financial Risk Management April 12, 1999 April 12, 1999 Securitization of Securitization of Catastrophe Risk: Catastrophe Risk: A USAA Example A USAA Example Presented by: Rhonda K. Aikens Executive Director, Financial Actuary USAA
31
Embed
1 Presentation to: The CAS Seminar on Financial Risk Management April 12, 1999 Securitization of Catastrophe Risk: A USAA Example Presented by: Rhonda.
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
1
Presentation to: Presentation to: The CAS Seminar on The CAS Seminar on
Securitization of Securitization of Catastrophe Risk:Catastrophe Risk:
A USAA ExampleA USAA Example
Presented by: Rhonda K. AikensExecutive Director, Financial Actuary
USAA
2
Objective of BriefingObjective of Briefing
To summarize the Residential ReTo summarize the Residential Re
transaction and its implicationstransaction and its implications
for USAA, the P&C Insurance Industryfor USAA, the P&C Insurance Industry
and investors.and investors.
3
How will USAA insulate itselfHow will USAA insulate itselffrom the next mega-hurricane?from the next mega-hurricane?
4
Hurricane Andrew made landfall in South Dade County Florida devastating Hurricane Andrew made landfall in South Dade County Florida devastating Homestead Air Force Base.Homestead Air Force Base.
5
1992 Hurricane Andrew1992 Hurricane Andrew
USAAUSAA$600,000,000$600,000,000
IndustryIndustry$16,500,000,000$16,500,000,000
6
A stormA stormthe sizethe sizeof Andrewof Andrew
just just 40 mi.40 mi.northnorth would wouldhave resultedhave resultedin insuredin insuredlosses oflosses ofoverover
$50 billion$50 billion
HAFBHAFB
Miami40 miles
north
Miami40 miles
north
7
Exposure to Mega-HurricaneEstimated U.S. Insured Losses (1/500 Yr.)Exposure to Mega-Hurricane
Since 1989, a series of natural disasters has resulted in variability in Since 1989, a series of natural disasters has resulted in variability in insurance losses.insurance losses.
Prior to Hurricane Hugo, the insurance industry had never suffered Prior to Hurricane Hugo, the insurance industry had never suffered losses from a single disaster over $1 Billion.losses from a single disaster over $1 Billion.
Since then, 11 natural disasters have exceeded this amount.Since then, 11 natural disasters have exceeded this amount.
Traditional reinsurance mechanisms are limited in capacity.Traditional reinsurance mechanisms are limited in capacity.
Recent events have caused the insurance industry to reconsider its Recent events have caused the insurance industry to reconsider its approach in handling low frequency, high severity occurrences.approach in handling low frequency, high severity occurrences.
The questions have centered around the following:The questions have centered around the following:
— What steps can we take toWhat steps can we take to reduce lossesreduce losses from future disasters? from future disasters?— What steps can we take to What steps can we take to reduce variabilityreduce variability in insurer results in insurer results
from future disasters?from future disasters?
9
Serving members who live in catastrophe-prone Serving members who live in catastrophe-prone areas requires maintenance of a high level of areas requires maintenance of a high level of capitalization and liquidity.capitalization and liquidity.
If such exposures could be mitigated, then If such exposures could be mitigated, then transferred or separately securitized, USAA could transferred or separately securitized, USAA could more efficiently deploy its capital resources.more efficiently deploy its capital resources.
Strategic Challenge:USAA Perspective
Strategic Challenge:USAA Perspective
10
Options Considered By USAAOptions Considered By USAATo AddressTo Address
The Strategic ChallengeThe Strategic Challenge
Options Considered By USAAOptions Considered By USAATo AddressTo Address
The Strategic ChallengeThe Strategic Challenge
Expanded Traditional ReinsuranceExpanded Traditional Reinsurance
Catastrophe BondsCatastrophe Bonds
Catastrophe OptionsCatastrophe Options
Surplus Notes and Contingent Surplus NotesSurplus Notes and Contingent Surplus Notes
Contingent EquityContingent Equity
Catastrophe SwapsCatastrophe Swaps
11
Options’ Issue: Options’ Issue: Financing vs. HedgingFinancing vs. Hedging
Potentially attractive to investorsPotentially attractive to investors
17
Special Purpose ReinsurerSpecial Purpose Reinsurer How it Works How it Works
CompanyCompany SPR SPR ReinsuranceReinsurance
PremiumPremium
InvestorInvestor
To secure obligations To secure obligations under the Reinsurance under the Reinsurance
AgreementAgreement
Reg 114 TrustReg 114 TrustAccountAccount
18
The Reinsurance AgreementThe Reinsurance AgreementThe Reinsurance AgreementThe Reinsurance Agreement
Obligates Residential Reinsurance to pay USAA Obligates Residential Reinsurance to pay USAA for the claims in the layer between $1.0 billion for the claims in the layer between $1.0 billion and $1.5 billion resulting from a single Class 3, and $1.5 billion resulting from a single Class 3, 4 or 5 hurricane in the Covered States during a 4 or 5 hurricane in the Covered States during a 12 month claims period.12 month claims period.
USAA will retain not less than 10% of the risk.USAA will retain not less than 10% of the risk.
19
Catastrophe Bond Catastrophe Bond Transaction TimelineTransaction Timeline
Catastrophe Bond Catastrophe Bond Transaction TimelineTransaction Timeline
June 15, 1998 - May 31, 1999June 15, 1998 - May 31, 1999 June 1, 1999 -June 1, 1999 -
Dec 1, 1999Dec 1, 1999
Risk PeriodRisk PeriodExtended Extended
ClaimsClaimsPeriodPeriod
June 1June 1 Dec 1Dec 1 June 1June 1 Dec 1Dec 1
Typical Hurricane SeasonTypical Hurricane Season
20
Key Issues EncounteredKey Issues Encountered Federal TaxFederal Tax
– SPR off-shoreSPR off-shore– Debt vs. equity interestDebt vs. equity interest
RegulatoryRegulatory– Recognition that investors are not in the business Recognition that investors are not in the business
of insuranceof insurance
SecuritiesSecurities– Public vs. private offeringPublic vs. private offering
Bond StructureBond Structure– Principal at risk vs. principal protectedPrincipal at risk vs. principal protected– Single year vs. multi-year transactionSingle year vs. multi-year transaction
21
The Investor’s The Investor’s PerspectivePerspective
22
Why Do I Buy?Why Do I Buy?Why Do I Buy?Why Do I Buy?
What Do I Need To Know? What Do I Need To Know? Questions that need to be answered from Investor’s PerspectiveQuestions that need to be answered from Investor’s Perspective
What Do I Need To Know? What Do I Need To Know? Questions that need to be answered from Investor’s PerspectiveQuestions that need to be answered from Investor’s Perspective
How do I assess the risk ?How do I assess the risk ?
How credible is the risk assessment ?How credible is the risk assessment ?
When do I feel that I have become educated enough to buy ?When do I feel that I have become educated enough to buy ?
Is this the first transaction of this kind?Is this the first transaction of this kind?
Is there a pipeline of future deals to further increase Is there a pipeline of future deals to further increase diversification ?diversification ?
Why have they bypassed the reinsurance market ?Why have they bypassed the reinsurance market ?
Can I afford to lose all my principal ?Can I afford to lose all my principal ?
What are the regulatory impacts (especially for life insurers and What are the regulatory impacts (especially for life insurers and pensions funds) ?pensions funds) ?
Isn’t one year too short; wouldn’t a multi-year commitment Isn’t one year too short; wouldn’t a multi-year commitment improve the utility of this instrument ?improve the utility of this instrument ?
24
Who Are The Investors?Who Are The Investors?Who Are The Investors?Who Are The Investors?
Bottom line: 90 - 95% of the money is new to the P&C Insurance Bottom line: 90 - 95% of the money is new to the P&C Insurance Industry. This is “found money”; capital that would never have Industry. This is “found money”; capital that would never have been applied to the problem of catastrophe protection through been applied to the problem of catastrophe protection through either investment in primary insurers or reinsurers.either investment in primary insurers or reinsurers.
25
Categories Of Investors:Categories Of Investors:This is a Global MarketThis is a Global MarketCategories Of Investors:Categories Of Investors:This is a Global MarketThis is a Global Market
Life InsurersLife Insurers
Pension FundsPension Funds
Reinsurers Reinsurers
Hedge FundsHedge Funds
BanksBanks
Investment AdvisorsInvestment Advisors
26
Wall Street JournalWall Street JournalJune 18, 1997June 18, 1997Wall Street JournalWall Street JournalJune 18, 1997June 18, 1997
27
Even Nature Even Nature Can Be TurnedCan Be Turned Into a SecurityInto a Security
High Yield and Big Risk High Yield and Big Risk With Catastrophe BondsWith Catastrophe Bonds
Even Nature Even Nature Can Be TurnedCan Be Turned Into a SecurityInto a Security
High Yield and Big Risk High Yield and Big Risk With Catastrophe BondsWith Catastrophe Bonds
THE NEW YORK TIMESAUGUST 6, 1997THE NEW YORK TIMESAUGUST 6, 1997
28
ObservationsObservationsObservationsObservations Traditional reinsurance capacity is plentiful, but limited.Traditional reinsurance capacity is plentiful, but limited.
Capital markets offer the potential to supply additional capacity.Capital markets offer the potential to supply additional capacity.
USAA’s success in renewing its transaction at reduced cost is evidence USAA’s success in renewing its transaction at reduced cost is evidence that:that:
1. Securitization of catastrophe risk on a large scale is 1. Securitization of catastrophe risk on a large scale is possible and sustainable.possible and sustainable.
2. Improving efficiency and cost is also possible; multi-year 2. Improving efficiency and cost is also possible; multi-year transaction could help in this regard.transaction could help in this regard.
Note: There have been about 21 capital market risk Note: There have been about 21 capital market risk transfer securitizations to date.transfer securitizations to date.
29
ObservationsObservationsContinuedContinued
ObservationsObservationsContinuedContinued
Growth of capital markets reinsurance will be slow due to:Growth of capital markets reinsurance will be slow due to:
1. Lack of expertise, basis risk/low risk transfer/speculative 1. Lack of expertise, basis risk/low risk transfer/speculative nature of investment, accounting and regulatory restrictions nature of investment, accounting and regulatory restrictions
(index options) (index options)
2. High transactions costs, tax issues/offshore nature, need 2. High transactions costs, tax issues/offshore nature, need for for more investor education (indemnity catastrophe bonds) more investor education (indemnity catastrophe bonds)
3. Soft traditional reinsurance market with large capacity 3. Soft traditional reinsurance market with large capacity and declining reinsurance prices. and declining reinsurance prices.
Significant growth in capital market reinsurance will requireSignificant growth in capital market reinsurance will require::
1. Addressing the issues mentioned above.1. Addressing the issues mentioned above.
2. NAIC adopting changes to support securitization of insurance.2. NAIC adopting changes to support securitization of insurance.
3. Changes at the Federal level and removal of tax disincentives so these 3. Changes at the Federal level and removal of tax disincentives so these SPR transactions can take place on-shore SPR transactions can take place on-shore..
30
ConclusionConclusionConclusionConclusion
This pioneering (and now renewed), mutually This pioneering (and now renewed), mutually beneficial transaction fulfills the strategic purposes of:beneficial transaction fulfills the strategic purposes of:
– Tapping into the vast pool of capital for capacity.Tapping into the vast pool of capital for capacity.
– Introducing a new asset class which supplements Introducing a new asset class which supplements reinsurance.reinsurance.
– Providing a vehicle for investors to increase yield,Providing a vehicle for investors to increase yield,while reducing portfolio risk through while reducing portfolio risk through diversification.diversification.