1. Catastrophe Bonds - A risk-linked debt security that transfers a specified form of catastrophe risk from a company to investors.
2. Collateralized Reinsurance - A reinsurance agreement that is fully collateralized, typically by unrated third party capital
3. Side Cars - A limited purpose company created to assume a pre-defined portion of insurance policies from an issuing insurance carrier
4. Collateralized Industry Loss Warranty - A contract that pays out for events greater than a pre-defined loss threshold.
CATASTROPHE BOND STRUCTURE
1. Special Purpose Vehicle (“SPV”) established to write a reinsurance agreement and exists solely to write the specific transaction
2. Investors purchase bonds issued by SPV. Funds raised collateralize the reinsurance agreement
3. Investors receive interest income on the invested funds plus a premium (interest spread) for the risk assumed.
4. No Loss Events - Principal repaid to investors with interest, as planned
5. Loss Events - Insured (sponsor) has transferred catastrophe risk and receives loss payment from the SPV.
6. Loss Events - Bad news for investors, there are insufficient funds in the SPV to fully repay investors. (i.e. full or partial default)
ALTERNATIVE MARKET DEVELOPMENT
CAT BONDS PARTICIPANTS
INSURANCE LINK SECURITIES BENCHMARK SPREADS RELATIVE TO (BB) CORPORATE BONDS
Note:
- Expected BB Corp Return: Yield less S&P Default Rate
- Expected ILS Return: Yield less Expected Loss
CAT BONDS LOSS BY YEAR
Note:
- Modeled loss value determined with near/medium term rates when noted
- Actual loss excludes $147M Credit Loss 2008
ADVANTAGES OF ALTERNATIVE CAPITALS
1. Catastrophe risk is not correlated to the economic cycle, making catastrophe risk linked assets a diversifying asset class.
2. Cat Bond terms are spreads above LIBOR.
3. The ILS market is still extremely small relative to the total debt market and the institutional investor asset base.
4. Catastrophe risk models have a more stable foundation than credit risk models.
5. Yields are converging towards similarly rated debt securities with defaults characteristics that are less correlated to the general economy.
6. Stress testing the market for significant catastrophe events demonstrates loss estimates are much less than issuance capacity.
