Insurance-Linked Securitiesthoughtleadership.aonbenfield.com/Documents/201207... · The Travelers Indemnity Company Long Point Re III Ltd. Series 2012-1 Class A $250 NE HU Indemnity

Insurance-Linked SecuritiesSecond Quarter Update 2012

Insurance-Linked Securities 2012: Second Quarter Update

2

The second quarter of 2012 closed strongly with the successful issuance of USD2.1 billion of new catastrophe bonds. The first quarter was the most active on record and total issuance in the first half reached USD3.6 billion, just short of the all-time high of USD3.8 billion for the same period in 2007. Both seasoned investors and newer entrants to the ILS space continued to receive strong capital inflows. With a solid pipeline for the second half of the year, annual issuance is likely to reach USD6.0 billion.

The table below summarizes the terms of the deals that closed during the second quarter.

Q2 Catastrophe Bond Issuance

Beneficiary Issuer Series Class Size

(millions)Covered

Perils Trigger RatingExpected

LossInterest Spread

Louisiana Citizens Property Insurance Corporation Pelican Re Ltd. Series 2012-1 Class A $125 LA HU Indemnity Not Rated 3.54% 13.75%

Allianz Argos 14 GmbH Blue Danube Ltd. Series 2012-1Class A

$120 US HU, EQ; MX HU; CAN EQ

Industry IndexBB+ (S&P) .59% 6.00%

Class B BB- (S&P) 1.77% 10.75%

Mitsui Sumitomo Insurance Co Akibare II Ltd. Series 2012-1 Class A $130 JP TY Modeled Loss BB (S&P) 1.04% 3.75%

Citizens Property Insurance Corporation Everglades Re Ltd. Series 2012-1 Class A $750 FL HU Indemnity B+ (S&P) 2.89% 17.75%

Swiss Reinsurance Company Mythen Ltd. Series 2012-1

Class A $50 US HU

Industry Index

Ba3 (Moody's) 1.23% 8.50%

Class E $100 US HU Ba3 (Moody's) .99% 8.00%

Class H $250 US HU, EU W B2 (Moody's) 2.44% 11.00%

United Services Automobile AssociationResidential Reinsurance 2012 Limited

Series 2012-1

Class 3 $50

US HU, EQ, ST, WS, WF Indemnity

BB- (S&P) 1.82% 10.00%

Class 5 $110 BB (S&P) .58% 8.00%

Class 7 $40 Not Rated 6.94% 22.00%

The Travelers Indemnity Company Long Point Re III Ltd. Series 2012-1 Class A $250 NE HU Indemnity BB+ (S&P) .88% 6.00%

Total Closed During Q2 $2,095

Second Quarter 2012 Catastrophe Bond Transaction Review

CAN — CanadaEU — EuropeFL — Florida

JP — JapanLA — LouisianaMX — Mexico

NE — NortheastUS — United StatesEQ — Earthquake

ST — Severe ThunderstormTY — TyphoonW — Windstorm

WF — WildfireWS — Winter Storm

LegendSource: Aon Benfield Securities, Inc.

Primary U.S. insurers are increasingly utilizing indemnity coverage in the catastrophe bond market. In the first quarter, Liberty Mutual Insurance Company successfully moved from an industry trigger to indemnity. The Travelers Indemnity Company (“Travelers”) made a similar decision in the second quarter, moving to indemnity coverage with Long Point Re III Ltd., which was upsized from USD150 million to USD250 million.

Both new and repeat sponsors closed transactions in the second quarter. Two new market participants, Louisiana Citizens Property Insurance Corporation and Citizens Property Insurance Corporation, successfully upsized capacity for their regional deals which closed within marketed price guidance. Repeat cedents included Allianz Argos 14 GmbH with Blue Danube Ltd., which expanded its coverage from the prior Blue Fin Ltd. transactions to include Mexico hurricane and Canada earthquake.

Catastrophe Bond Issuance by Quarter

Source: Aon Benfield Securities, Inc.

0

1,000

2,000

3,000

4,000

5,000

6,000

20122011201020092008

$ M

illio

ns

716

810

575

411

1,675

1,015

742

853

1,988

1,493

2,095

1,794

320

300

2,350

232

2,395

Q1

Q2

Q3

Q4

3

Aon Benfield Securities

Aon Benfield ILS Indices

Index Title Index ValueReturn for Quarterly Period

Ending June 30Return for Annual Period

Ending June 30

Aon Benfield ILS Indices 6/30/2012 3/31/2012 6/30/2011 3/31/2011 2012 2011 2012 2011

All Bond Bloomberg Ticker (AONCILS)

246.82 240.25 234.08 231.17 2.74% 1.26% 5.45% 5.97%

BB-rated Bond Bloomberg Ticker (AONCBB)

235.08 229.36 221.48 218.24 2.49% 1.49% 6.14% 4.52%

U.S. Hurricane Bond Bloomberg Ticker (AONCUSHU)

244.20 239.56 231.13 231.35 1.94% -0.09% 5.65% 8.51%

U.S. Earthquake Bond Bloomberg Ticker (AONCUSEQ)

208.07 203.35 202.08 197.73 2.32% 2.20% 2.96% 7.21%

Benchmarks

3-5 Year U.S. Treasury Notes 325.19 321.33 310.87 302.45 1.20% 2.78% 4.61% 3.53%

3-Year U.S. Corporate BB 429.97 425.74 404.60 400.04 0.99% 1.14% 6.27% 7.43%

S&P 500 1362.16 1408.47 1320.64 1325.83 -3.29% -0.39% 3.14% 28.13%

ABS 3-5 Year, Fixed Rate 357.07 350.94 337.20 329.35 1.75% 2.38% 5.89% 6.37%

CMBS Fixed Rate 3-5 Year 278.16 274.31 256.63 252.42 1.41% 1.67% 8.39% 8.87%

Source: Aon Benfield Securities Inc., Bloomberg

The Aon Benfield ILS Indices are calculated by Thomson Reuters using month-end price data provided by Aon Benfield Securities.1 While all bond indices posted negative returns in the quarter ending March 31, 2012 due to mark-to-market losses, ILS returns rebounded in the second quarter driven by mark-to-market gains. The All Bond and BB-rated Bond Indices were up 2.74 percent and 2.49 percent, respectively. At the same time, the U.S. Hurricane Bond and U.S. Earthquake Bond Indices increased 1.94 percent and 2.32 percent, respectively. For the trailing

12 months all indices posted gains. The Aon Benfield All Bond and BB-rated Bond indices posted returns of 5.45 percent and 6.14 percent while the U.S. Hurricane and U.S. Earthquake Bond indices posted returns of 5.65 percent and 2.96 percent, respectively.

Demand for ILS continues to outstrip available supply. At a time when primary issuance is historically light, we expect gains to continue into the third quarter as the market experiences strong inflows.

Aon Benfield ILS Indices

1 The 3-5 Year U.S. Treasury Notes Index is calculated by Bloomberg and simulates the performance of U.S. Treasury notes with maturities ranging from three to five years.

The 3-Year U.S. Corporate BB Index is calculated by Bloomberg and simulates the performance of corporate bonds rated BB on a zero coupon basis. Zero coupon yields are derived by stripping the par coupon curve. The maturities of the BB rated bonds in this index are three years.

The S&P 500 is Standard & Poor's broad-based equity index representing the performance of a broad sample of 500 leading companies in leading industries. The S&P 500 Index represents price performance only, and does not include dividend reinvestments or advisory and trading costs.

The ABS 3-5 Year, Fixed Rate Index is calculated by Bank of America Merrill Lynch (BAML) and tracks the performance of U.S. dollar denominated investment grade fixed rate asset backed securities publicly issued in the U.S. domestic market with terms ranging from three to five years. Qualifying securities must have an investment grade rating, a fixed rate coupon, at least one year remaining term to final stated maturity, a fixed coupon schedule, and an original deal size for the collateral group of at least $250 million.

The CMBS Fixed Rate 3-5 Year Index is calculated by BAML and tracks the performance of U.S. dollar denominated investment grade fixed rate commercial mortgage backed securities publicly issued in the U.S. domestic market with terms ranging from three to five years. Qualifying securities must have an investment grade rating, at least one year remaining term to final maturity, a fixed coupon schedule, and an original deal size for the collateral group of at least $250 million. The performance of an index will vary based on the characteristics of, and risks inherent in, each of the various securities which comprise the index. As such, the relative performance of an index is likely to vary, often substantially, over time. Investors cannot invest directly in indices.

Past performance is no guarantee of future results

Japan sponsors continue to utilize catastrophe bonds as part of their overall risk transfer program. In 2012, two Japanese cedents, Zenkyoren and Mitsui Sumitomo Insurance Co., Ltd. (“MSI”) have returned to the markets. Zenkyoren successfully secured USD300 million in earthquake capacity in the first quarter through Kibou Ltd., following the full recovery on Muteki Ltd. in 2011. MSI successfully replaced typhoon coverage from the matured Akibare Ltd. through Akibare II Ltd., which closed in April and provides USD130 million of typhoon coverage on a modeled loss basis.

On the traditional reinsurance side, many Asia ex-Japan and Australasia insurers’ programs renewed in June and July. Even though 2011 ranked first for reinsured catastrophe losses, insurers in New Zealand, Japan, Thailand and Australia, which have been extensive users of reinsurance, were able to protect their earnings and capital from very material direct losses.2

In the second quarter, the reinsurance market continued to provide the required capacity at accretive terms and conditions for these insurers. The size of the 2011 ceded losses caused many reinsurers to fundamentally re-evaluate their risk assuming strategies in the affected regions.2 Insurance companies in these regions continue to evaluate the use of ILS as part of their overall risk transfer programs.

Asia and Pacific Region

2 Source: Aon Benfield Reinsurance Market Outlook June and July 2012 Update


4

Secondary prices began the year under selling pressure which caused investors to experience mark-to-market losses on their positions. There was also a general concern regarding the availability of capacity in the primary market. As cedents looked to attract investor interest, enhanced disclosures became more common. Prices started to stabilize toward the end of the first quarter and remained relatively flat through April. However, in May, strong investor demand resulted in price increases, which impacted diversifying non-U.S. hurricane bonds first. By June, the increases had spread broadly across the market.

Early in the second quarter, inflows were strong with both small and large investors alike having excess capital to deploy. Nearly USD2.1 billion of new issues closed while under USD1.4 billion matured in the quarter. Since the additional USD700 million of bonds was not enough to satisfy the amount of new capital coming into the space, investors looked to acquire bonds in the secondary market. Trading volumes were very strong, however there were insufficient bonds to meet the increased demand. Broadly speaking, the majority of investors did not want to sell positions for fear that they would sit on cash without having other bonds to purchase. There were opportunities, however, to swap out positions. By the end of the second quarter, some investors, rather than waiting on the sidelines with uninvested funds, began to pay higher prices for bonds.

Region / Peril Price Change Mar 31 to Jun 30

U.S. hurricane 0.85%

U.S. earthquake 0.95%

Europe 0.29%

Japan 0.87%

U.S. hurricane bonds dominated new issuance in the second quarter; however investors received some diversification with Akibare II Ltd., which covered Japan typhoon. Additional investors were able to diversify within the U.S. hurricane bucket, as several regional deals came to market including:

• Louisiana-exposed Pelican Re Ltd.;

• Florida-exposed Everglades Re Ltd.; and

• Northeast-exposed Long Point Re III Ltd.

As we enter the third quarter, earlier capacity concerns appear to have eased. Given the excess supply of capital, upcoming transactions are likely to be rewarded with lower spreads. We expect the narrowing of spreads to continue through the hurricane season.

ILS Sales and Distribution

The continued uncertainty resulting from the Eurozone crisis has had a negative impact on the insurance industry. A number of large European insurance and reinsurance companies have been downgraded due to their direct exposure to sovereign debt and concerns about the implied weaknesses in the wider macro economy. Recent sovereign downgrades have also indirectly affected insurance and reinsurance companies, with Spanish insurers and reinsurers being notable victims.

This high level of uncertainty has increased concern among many cedents about the security of traditional reinsurance and the potential for a shortfall on recoveries following a major catastrophe. Although the overall probability of a failure to pay is very small, risk managers and sponsors alike are increasingly taking a more prudent approach to counterparty credit risk. In addition, the increased focus on credit risk under Solvency II requirements is accelerating this trend. As a consequence, more sponsors are now considering collateralized solutions such as ILS due to the reduced failure-to-pay risk associated with these products.

Some market commentators believe that a potential Greek exit, severely unsettling for the whole area, could be a forerunner to a partial or full break-up of the Eurozone. In this instance, the catastrophe bond market will no longer be immune to the effects of a break-up. This may lead to the introduction of an additional early redemption event, allowing the cedent to terminate the transaction if the Euro no longer exists as a currency.

According to law firm Mayer Brown, a Eurozone breakup could also impact catastrophe bond structures that insure on an indemnity or indexed basis and are associated with losses in an existing Eurozone country. A PERILS-based index that tracks property losses in Europe and in countries such as Denmark, the United Kingdom and Switzerland, that are outside the currency union, can report losses in local currency and convert losses to Euros using the conversion rate at the time of the commencement of the loss event. Indexed-based catastrophe bond transactions will typically utilize a fixed conversion factor for these countries established at the outset of the transaction. Some recently issued catastrophe bonds have included a provision to allow for the contingency of a departing country. Under the provision, losses can be determined in the new local currency and then converted into Euros at the rate established at the time of departure. PERILS have also indicated that they would apply a conversion rate for any new currency of a departing state at the time of the loss event. Consideration is now being given in other transactions for determining the conversion rate consistent with this PERILS methodology.

The above development does add a degree of currency risk for investors. Modeled risk analysis for catastrophe bonds during this uncertain time will not be able to adjust for the impact of currency changes, except upon future resets. It is still not clear if this impact will be positive or negative.

Clearly, if the Eurozone crisis is not resolved soon, both the catastrophe bond market and the wider capital markets will be affected.

Europe

Selected European Insurer and Reinsurer Financial Strength Ratings

Company A.M. Best S&P

January 1, 2011 June 28, 2012 January 1, 2011 June 28, 2012

Allianz A+ Stable A+ Negative AA Stable AA Negative

Aviva A Positive A Negative AA- Negative AA- Watch (-ve)

AXA A Stable A Negative AA- Stable AA- Negative

Caisse Centrale A++ Stable A++ Negative AAA Stable AA+ Negative

Flagstone A- Stable A- Negative NR - NR -

Generali A+ Stable A+ Negative AA- Stable A Watch (-ve)

Groupama - - - - A- Stable BB Negative

Mapfre Re A Stable A Negative AA Negative A- Negative

Source: A.M. Best, Standard & Poor's as of June 28, 2012

5

Aon Benfield Securities

1. What was the rationale for the Mystic Re III transaction?

The rationale was to structure and design sustainable nationwide multi-year indemnity Catastrophe Bond protection and embed it into our nationwide Excess of Loss reinsurance tower. The transaction also provided Liberty Mutual Insurance with access to a valuable alternative source of reinsurance security.

2. As a repeat sponsor, what made you return to the market after a three-year absence?

While Liberty Mutual Insurance is committed to the ILS market, we carefully weigh all the alternatives to ensure that the protection purchased helps us achieve our goals. This year, we felt that the traditional reinsurance market offered less value than in previous years, so we returned to the ILS market.

3. What made you decide to move from a PCS index to an indemnity structure?

Indemnity protection better reflects our ability to measure, manage and mitigate our peak risk and allows the protection to sit side by side with our traditional program. An indemnity structure is more appealing from a long-term perspective.

4. How important is the ILS market to Liberty Mutual Insurance going forward?

The fully collateralized, multi-year aspect of an ILS market transaction is attractive to Liberty Mutual Insurance. The ability to obtain nationwide indemnity protection through Mystic Re III means that the 2012 issue is of significantly greater value to Liberty Mutual Insurance than previous deals and will encourage us to continue to explore opportunities in this market.

5. In your opinion, what factors will help grow the ILS market?

The ILS market for property catastrophe would grow further if the market could offer the same types of coverage as traditional reinsurers, including but not limited to reinstatements and indemnity protection for complex commercial business. Creative ways could be developed for ILS markets so they can be utilized more often for casualty catastrophe protection. Lastly, the ILS market would grow if the transactional fees associated with the transaction and claims collection process were reduced, or at least effectively managed and capped.

6. What would be the ideal split for Liberty Mutual Insurance between traditional and ILS coverage given capacity?

There is no ideal split in mind. As Manager of Ceded Reinsurance for Liberty, my paramount goal is to utilize financially secure reinsurers or fully collateralized reinsurers on our programs who pay our claims promptly in the event of a loss. Our view is that ILS and traditional reinsurance coverage have desirable attributes and that both are valuable types of coverage to utilize for our property catastrophe program. In addition, Liberty Mutual Insurance is committed to the traditional market. We value the longstanding trading relationships with these partners, their history of paying claims, their service, expertise and knowledge.

An Interview With Elaine Caprio Brady, Vice President and Manager of Ceded Reinsurance, Liberty Mutual Insurance


6

Aon Benfield200 E. Randolph Street Chicago, Illinois 60601 t +1.312.381.5300 f +1.312.381.0160 aonbenfield.com

© Aon Benfield Inc., 2012. All rights reserved.This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon Benfield’s preliminary analysis of publicly available information. The content of this document is made available on an “as is” basis, without warranty of any kind. Aon Benfield disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Aon Benfield reserves all rights to the content of this document.#9944 - 7/2012

Aon Benfield Securities, Inc. and Aon Benfield Securities Limited (collectively, “Aon Benfield Securities”) provide insurance and reinsurance clients with a full suite of insurance-linked securities products, including catastrophe bonds, contingent capital, sidecars, collateralized reinsurance, industry loss warranties, and derivative products.

As one of the most experienced investment banking firms in this market, Aon Benfield Securities offers expert underwriting and placement of new debt and equity issues, financial and strategic advisory services, as well as a leading secondary trading desk. Aon Benfield Securities’ integration with Aon Benfield’s reinsurance operation expands its capability to provide distinctive analytics, modeling, rating agency, and other consultative services.

Aon Benfield Inc., Aon Benfield Securities, Inc. and Aon Benfield Securities Limited are all wholly-owned subsidiaries of Aon plc. Securities advice, products and services described within this report are offered solely through Aon Benfield Securities, Inc. and/or Aon Benfield Securities Limited.