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LUCA ALBERTINI is Chief Executive Officer of Leadenhall Capital Partners, an asset management company dedicated to insurance linked investments strategies. Luca has over 16 year’s securitisation experience, having worked at Citibank, GE Capital, Credit Suisse First Boston and at Swiss Re, where he became responsible for the European Insurance Linked Securities team.
About the Contributors | p. XV |
Acknowledgements | p. xxv |
Introduction | p. 1 |
Non-Life Securitisation | p. 7 |
Non-Life Insurance Securitisation: Market Overview, Background and Evolution | p. 9 |
Market overview | p. 9 |
Market dynamics | p. 14 |
The question of basis risk remains | p. 16 |
ILS and the credit crunch | p. 18 |
Cedants' Perspectives on Non-life Securitization | p. 19 |
Insurance-linked securities as part of advanced risk intermediation | p. 21 |
Motivation for Allianz to take part in ILS activities | p. 21 |
Objectives of insurance companies | p. 23 |
Case study: Blue Fin Ltd | p. 24 |
References | p. 28 |
Reinsurance vs Securitisation | p. 29 |
Keeping risk vs transferring it | p. 30 |
Reinsurance vs securitisation | p. 30 |
Application to main P&C risks | p. 31 |
Case studies: Aura Re and Sparc | p. 32 |
Limits and success factors to securitisation | p. 33 |
References | p. 34 |
Securitisation as a diversification from traditional retrocession | p. 35 |
Choice of Triggers | p. 37 |
General aspects | p. 37 |
Indemnity triggers | p. 38 |
Scope of coverage | p. 39 |
Payout timing | p. 39 |
Loss verification | p. 40 |
Transparency | p. 40 |
Non-indemnity triggers | p. 41 |
Parametric triggers (pure and index) | p. 41 |
Industry loss triggers | p. 43 |
Modelled loss triggers | p. 45 |
Choosing the optimal trigger | p. 45 |
Comparison of trigger types | p. 46 |
Choice of trigger and alternative solutions | p. 47 |
Basis Risk from the Cedant's Perspective | p. 49 |
Introduction | p. 49 |
Investor vs sponsor risk | p. 50 |
Trigger types | p. 50 |
Catastrophe models | p. 52 |
Key components of catastrophe models | p. 52 |
Uncertainty | p. 54 |
Sources of basis risk | p. 55 |
Source 1: Catastrophe model error/shortcomings | p. 55 |
Source 2: Discrepancy between the modelled index loss and the modelled company loss | p. 56 |
Source 3: Dynamic basis risk | p. 56 |
Defining basis risk | p. 56 |
Quantifying basis risk | p. 58 |
Measures for pro rata hedges | p. 58 |
Measures for digital hedges | p. 59 |
Measuring positive basis risk | p. 59 |
Minimising basis risk | p. 60 |
Over-hedging | p. 60 |
Choice of index | p. 62 |
Reset clauses | p. 62 |
Cat model input | p. 63 |
Conclusion | p. 63 |
Acknowledgements | p. 63 |
References | p. 64 |
Rating Methodology | p. 65 |
Standard & Poor's ratings services' rating process | p. 65 |
Initial interaction | p. 65 |
Risk analysis | p. 65 |
Documentation review | p. 67 |
Transaction closing | p. 67 |
Surveillance | p. 67 |
Risk analysis | p. 68 |
Trigger options | p. 68 |
Indemnity vs non-indemnity triggers | p. 68 |
Risk factors | p. 70 |
Adjusted probability of default | p. 72 |
Application of methodology | p. 73 |
Default table | p. 74 |
Multi-event criteria | p. 74 |
Legal and swap documentation review process | p. 75 |
Insurance focus points | p. 75 |
Legal and structural focus points | p. 75 |
Impact on sponsor | p. 75 |
Capital model treatment of ILS | p. 75 |
Summary of basis risk analysis | p. 76 |
Sources of basis risk | p. 77 |
Link to ILS revised probability of attachment | p. 82 |
References | p. 82 |
Risk Modelling and the Role and Benefits of Cat Indices | p. 83 |
Components of a cat model | p. 84 |
Insurance-linked securities | p. 84 |
General overview | p. 84 |
Insurance-linked security triggers | p. 85 |
Basis risk | p. 90 |
Cat indices | p. 93 |
Property Claims Service (PCS) | p. 93 |
Re-Ex - NYMEX | p. 93 |
Insurance Futures Exchange Service (IFEX) | p. 94 |
Carvill Hurricane Index (CHI) - Chicago Mercantile Exchange (CME) | p. 94 |
Paradex | p. 95 |
Summary | p. 99 |
Legal Issues | p. 101 |
The note offering - federal securities law implications | p. 101 |
The distribution of the notes | p. 101 |
Application of the anti-fraud provisions of the federal securities laws | p. 102 |
Securities offering reform | p. 103 |
Provision of information | p. 103 |
The Investment Company Act of 1940 | p. 104 |
The note offering - the offering circular | p. 104 |
Important terms | p. 104 |
ERISA considerations | p. 106 |
Other considerations regarding the proceeds and payment of interest | p. 109 |
The risk analysis | p. 110 |
Opinions | p. 110 |
Types of transactions | p. 110 |
Parametric, index and modeled loss transactions | p. 111 |
Indemnity transactions | p. 111 |
Conclusion | p. 115 |
The Investor Perspective (Non-Life) | p. 117 |
The creation of a sustainable and liquid market | p. 117 |
Creation of common terminology | p. 118 |
Risk analysis | p. 119 |
Correlation with other investments in the portfolio | p. 119 |
Relative value | p. 121 |
Valuation and liquidity | p. 121 |
Key transaction features from the investor perspective | p. 122 |
Assessment of the underlying risks being securitised | p. 122 |
Risk assessment of the instrument | p. 124 |
Pricing and risk-return profile | p. 125 |
Market evolution: the investor perspective | p. 127 |
Collateral arrangements | p. 127 |
Data transparency | p. 128 |
Exposure monitoring | p. 129 |
Modelling rigour | p. 129 |
ILS Portfolio Monitoring Systems | p. 131 |
Introduction | p. 131 |
Completing the circle | p. 131 |
'Square peg in a round hole?' | p. 132 |
Miu - An ILS platform in a convergent space | p. 133 |
Overview | p. 133 |
Nuts and bolts - how the platform works | p. 133 |
Step by step - entering a contract | p. 134 |
Portfolio analysis | p. 134 |
RMS library of cat bond characterisations | p. 137 |
Motivation and objectives | p. 137 |
How is it done? A bird's eye view | p. 137 |
Apples to apples - a leap for the market | p. 138 |
Conclusion | p. 138 |
The Evolution and Future of Reinsurance Sidecars | p. 141 |
A brief history of the brief history of sidecars | p. 142 |
Sidecar structures | p. 143 |
Basic structure | p. 143 |
Market-facing sidecar | p. 144 |
Non-market-facing sidecar | p. 145 |
Capitalising sidecars | p. 146 |
How sidecars and catastrophe bonds are different | p. 147 |
The appeal of sidecars | p. 148 |
From a cedant/sponsor perspective | p. 148 |
From an investor perspective | p. 149 |
Structuring considerations | p. 149 |
The outlook for sidecars | p. 150 |
Conclusion | p. 151 |
Case Study: A Cat Bond Transaction by SCOR (Atlas) | p. 153 |
Introduction: SCOR's recent history | p. 153 |
Atlas III and IV: Background | p. 153 |
Atlas: Main characteristics | p. 155 |
Basis Risk | p. 158 |
Reset | p. 158 |
Gross up | p. 158 |
Overlap | p. 158 |
Synthetic covers | p. 159 |
Total Return Swap | p. 160 |
Conclusion | p. 160 |
p. 161 | |
Definition of events | p. 161 |
Extension events | p. 162 |
Case Study: Swiss Re's New Natural Catastrophe Protection Program (Vega) | p. 163 |
A positive evolution of Swiss Re's ILS strategy | p. 163 |
Swiss Re accesses multi-event natural catastrophe coverage | p. 164 |
The first ILS to use a cash reserve account as credit enhancement | p. 164 |
Innovation leads to more efficient protection | p. 165 |
Life Securitisation | p. 167 |
General Features of Life Insurance-Linked Securitisation | p. 169 |
Life insurer corporate and business structures, risks and products | p. 170 |
Mutual life offices | p. 170 |
Proprietary life offices | p. 171 |
Other forms of life office | p. 173 |
Principal risks associated with life insurance business | p. 173 |
Principal product types and associated risks | p. 176 |
Actors and their roles | p. 177 |
Sponsor | p. 177 |
Investors | p. 179 |
Regulators | p. 179 |
External professional advisers | p. 179 |
Ratings agencies | p. 181 |
Monoline insurers | p. 181 |
Liquidity providers | p. 181 |
Swap providers | p. 182 |
Others | p. 182 |
Process | p. 182 |
Cedants' Perspectives on Life Securitisation | p. 189 |
A cedant's perspective on life securitisation | p. 191 |
Why Securitise? | p. 191 |
Life ILS can be complex | p. 194 |
Outlook for life ILS | p. 198 |
A cedant's perspective on life securitisation | p. 199 |
Key considerations | p. 199 |
Examples of securitisation opportunities | p. 202 |
Differences between securitisation and reinsurance | p. 205 |
Rating Methodology | p. 207 |
Fitch's approach to the rating process | p. 207 |
Insurance risk analysis | p. 208 |
Risk modelling | p. 208 |
Ratings benchmarks | p. 209 |
Analysis of sponsor and other counterparties | p. 210 |
Surveillance | p. 210 |
Zest: a VIF case study | p. 211 |
References | p. 212 |
Life Securitisation: Risk Modelling | p. 213 |
Modelling of a catastrophic mortality transaction | p. 213 |
Modelling of a VIF transaction | p. 216 |
Life Insurance Securitisation: Legal Issues | p. 219 |
Monetisation of future cash flows | p. 219 |
Some background on monetisation | p. 219 |
The market drivers of monetisation | p. 220 |
Monetisation in the current climate | p. 221 |
Some transaction structures | p. 221 |
Legal aspects of life insurance securitisation - some key features | p. 222 |
Closed book/open book | p. 222 |
Unit-linked policies - not 'with profits' policies | p. 222 |
Risk transfer versus no transfer | p. 222 |
Warranties | p. 222 |
Monoline wrap (payment obligation) | p. 223 |
Recharacterisation risk | p. 223 |
Some examples of value-in-force securitisation/monetisation | p. 225 |
A classical VIF structure: Gracechurch | p. 225 |
A private but reported transaction: Zest | p. 226 |
Outlook | p. 227 |
The Investor Perspective (Life) | p. 229 |
Life insurance-linked risks and investor appetite | p. 229 |
The role of the monolines | p. 229 |
Understanding the risk | p. 230 |
Correlation with other investments | p. 234 |
Relative value | p. 236 |
Valuation and liquidity | p. 237 |
Key transaction features from the investor perspective | p. 237 |
Risk assessment of the instrument | p. 237 |
Pricing and risk-return profile | p. 240 |
Market evolution: the investor perspective | p. 242 |
Longevity Securitisation: Specific Challenges and Transactions | p. 245 |
Mortality and longevity risk | p. 245 |
A market for longevity risk | p. 246 |
Potential sources of longevity risk for securitisation | p. 246 |
Demand for longevity risk | p. 247 |
Key structural aspects of longevity risk securitisation | p. 248 |
Isolating longevity risk | p. 248 |
Analysis of longevity risks | p. 249 |
Longevity risk - legal explanation | p. 250 |
Examples and legal aspects of transaction structures | p. 252 |
Some features of longevity risk | p. 255 |
Model risk | p. 255 |
Ratings | p. 258 |
Pricing | p. 258 |
Longevity Risk Transfer: Indices and Capital Market Solutions | p. 261 |
The nature of longevity risk | p. 262 |
The market for longevity risk transfer | p. 263 |
Hedgers | p. 263 |
Investors | p. 265 |
Intermediaries | p. 265 |
Importance of indices, tools and standards | p. 266 |
Longevity indices | p. 266 |
Trading and liquidity | p. 268 |
Capital market instruments for longevity risk transfer | p. 268 |
Longevity bond | p. 268 |
Survivor swap | p. 269 |
q-forward | p. 269 |
Survivor forward | p. 271 |
Instruments and liquidity | p. 272 |
Customised vs standardised longevity hedges | p. 273 |
Customised longevity hedge | p. 273 |
Standardised index-based longevity hedge | p. 273 |
Advantages and disadvantages | p. 274 |
Case study: customised longevity hedge | p. 274 |
Implementing a standardised index-based longevity hedge | p. 275 |
Liability sensitivity and hedge calibration | p. 276 |
Hedge effectiveness analysis | p. 278 |
Conclusions | p. 280 |
References | p. 280 |
Case Study: A Cat Mortality Bond by AXA (OSIRIS) | p. 283 |
Catastrophic pandemic risk | p. 283 |
Considered risk transfer tools | p. 284 |
Detailed structure | p. 285 |
Risk analysis | p. 287 |
Modelling approach | p. 287 |
Index Construction | p. 287 |
Investors' reaction | p. 288 |
Spread behaviour | p. 288 |
Next steps | p. 288 |
Reference | p. 291 |
Case Study: Some Embedded Value and XXX Securitisations | p. 293 |
Embedded value securitisation - Avondale S.A. | p. 295 |
XXX securitisation | p. 299 |
Tax and Regulatory Considerations | p. 305 |
The UK Taxation Treatment of Insurance-Linked Securities | p. 307 |
The Directive and the taxation of UK ISPVs | p. 308 |
The implementation of the Directive in the UK | p. 308 |
Implementation of the ISPV framework in the UK | p. 308 |
UK tax treatment of ISPVs | p. 310 |
Non-UK insurance special purpose vehicles | p. 315 |
Tax residence status of the issuer | p. 316 |
Tax residence status of the issuer's agents | p. 317 |
Location and management of the issuer's assets | p. 318 |
Indirect taxes and withholding of income tax | p. 320 |
Further reading | p. 321 |
The US Federal Income Taxation Treatment of Insurance-Linked Securities | p. 323 |
Avoiding US corporate income tax for the issuer | p. 324 |
Overview | p. 324 |
Trade or business in the United States | p. 325 |
Procedures followed by catastrophe bond issuers to avoid substantive business activities in the United States | p. 326 |
Section 864(b)(2) safe harbor | p. 328 |
Withholding tax and excise tax | p. 328 |
Overview | p. 328 |
Descriptions of insurance-linked instruments written on standard ISDA forms | p. 330 |
Federal income tax definition of notional principal contracts | p. 331 |
Put options | p. 334 |
The Bank of America case (income not clearly described within any other generally recognised category) | p. 334 |
US federal income tax treatment of an investor in a catastrophe bond issuer: overview | p. 335 |
US investors | p. 335 |
Timing and character of income and gain of the issuer with respect to the permitted investments, the total return swap and the insurance-linked instrument | p. 338 |
Foreign investors | p. 339 |
Notes that are treated as indebtedness for federal income tax purposes | p. 339 |
Reference | p. 339 |
Regulatory Issues and Solvency Capital Requirements | p. 341 |
Regulatory issues relevant for ILS sponsors | p. 341 |
Solvency capital | p. 341 |
Recognition of sponsors' claims against SPV as eligible assets | p. 342 |
Solvency I | p. 343 |
Overview | p. 343 |
Requirement to maintain a solvency margin | p. 344 |
Structuring ILS under EU Directives to enhance solvency margins | p. 348 |
Solvency II | p. 351 |
Valuation of assets and liabilities | p. 353 |
Determination of technical provisions | p. 353 |
Solvency capital requirement | p. 354 |
Minimum capital requirement | p. 358 |
Own funds | p. 359 |
Investments | p. 360 |
Standard formula, solvency capital requirement (SCR) | p. 361 |
Calculation of the basic solvency capital requirement | p. 361 |
Calculation of the non-life underwriting risk module | p. 361 |
Calculation of the life underwriting risk module | p. 362 |
Calculation of the market risk module | p. 362 |
Index | p. 363 |
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