The Handbook of Insurance-linked Securities

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  • Edition: 1st
  • Format: Hardcover
  • Copyright: 2009-08-10
  • Publisher: Wiley
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This book provides a much needed reference for finance practitioners on the rapidly growing Insurance Linked Securities markets. It will provide readers with the state of the art in Insurance-Linked Securitization, introducing the different parties involved in the transactions and their roles, the motivation for the transaction sponsors, the potential inherent pitfalls, the latest developments and transaction structures but also the key challenges faced by the market at each stage. The book will also focus on more general issues faced by the industry, including accounting and tax issues, regulatory issues and solvency capital requirements - all tackled from international perspectives.The book will be organized into two parts making a distinction between non-life and life securitization in order to accommodate the specificities of each sector. Each chapter covers a specific topic or sector of the market. After a general overview over the ILS market, the Insurance-Linked Securitization process is studied in detail.Contributions will be from leading practitioners in the field, and will feature case studies and worked examples to illustrate more complicated transactions and techniques.

Author Biography

Dr PAULINE BARRIEU is a Reader (associate professor) at the London School of Economics. She has two PhDs in Mathematics and in Finance. Her research interests are mainly on the study of problems at the interface between finance and insurance, in particular ILS. She also works on quantitative methods for risk measurement and robust decision taking, with applications in finance and environmental economics.

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.

Table of Contents

About the Contributorsp. XV
Acknowledgementsp. xxv
Introductionp. 1
Non-Life Securitisationp. 7
Non-Life Insurance Securitisation: Market Overview, Background and Evolutionp. 9
Market overviewp. 9
Market dynamicsp. 14
The question of basis risk remainsp. 16
ILS and the credit crunchp. 18
Cedants' Perspectives on Non-life Securitizationp. 19
Insurance-linked securities as part of advanced risk intermediationp. 21
Motivation for Allianz to take part in ILS activitiesp. 21
Objectives of insurance companiesp. 23
Case study: Blue Fin Ltdp. 24
Referencesp. 28
Reinsurance vs Securitisationp. 29
Keeping risk vs transferring itp. 30
Reinsurance vs securitisationp. 30
Application to main P&C risksp. 31
Case studies: Aura Re and Sparcp. 32
Limits and success factors to securitisationp. 33
Referencesp. 34
Securitisation as a diversification from traditional retrocessionp. 35
Choice of Triggersp. 37
General aspectsp. 37
Indemnity triggersp. 38
Scope of coveragep. 39
Payout timingp. 39
Loss verificationp. 40
Transparencyp. 40
Non-indemnity triggersp. 41
Parametric triggers (pure and index)p. 41
Industry loss triggersp. 43
Modelled loss triggersp. 45
Choosing the optimal triggerp. 45
Comparison of trigger typesp. 46
Choice of trigger and alternative solutionsp. 47
Basis Risk from the Cedant's Perspectivep. 49
Introductionp. 49
Investor vs sponsor riskp. 50
Trigger typesp. 50
Catastrophe modelsp. 52
Key components of catastrophe modelsp. 52
Uncertaintyp. 54
Sources of basis riskp. 55
Source 1: Catastrophe model error/shortcomingsp. 55
Source 2: Discrepancy between the modelled index loss and the modelled company lossp. 56
Source 3: Dynamic basis riskp. 56
Defining basis riskp. 56
Quantifying basis riskp. 58
Measures for pro rata hedgesp. 58
Measures for digital hedgesp. 59
Measuring positive basis riskp. 59
Minimising basis riskp. 60
Over-hedgingp. 60
Choice of indexp. 62
Reset clausesp. 62
Cat model inputp. 63
Conclusionp. 63
Acknowledgementsp. 63
Referencesp. 64
Rating Methodologyp. 65
Standard & Poor's ratings services' rating processp. 65
Initial interactionp. 65
Risk analysisp. 65
Documentation reviewp. 67
Transaction closingp. 67
Surveillancep. 67
Risk analysisp. 68
Trigger optionsp. 68
Indemnity vs non-indemnity triggersp. 68
Risk factorsp. 70
Adjusted probability of defaultp. 72
Application of methodologyp. 73
Default tablep. 74
Multi-event criteriap. 74
Legal and swap documentation review processp. 75
Insurance focus pointsp. 75
Legal and structural focus pointsp. 75
Impact on sponsorp. 75
Capital model treatment of ILSp. 75
Summary of basis risk analysisp. 76
Sources of basis riskp. 77
Link to ILS revised probability of attachmentp. 82
Referencesp. 82
Risk Modelling and the Role and Benefits of Cat Indicesp. 83
Components of a cat modelp. 84
Insurance-linked securitiesp. 84
General overviewp. 84
Insurance-linked security triggersp. 85
Basis riskp. 90
Cat indicesp. 93
Property Claims Service (PCS)p. 93
Re-Ex - NYMEXp. 93
Insurance Futures Exchange Service (IFEX)p. 94
Carvill Hurricane Index (CHI) - Chicago Mercantile Exchange (CME)p. 94
Paradexp. 95
Summaryp. 99
Legal Issuesp. 101
The note offering - federal securities law implicationsp. 101
The distribution of the notesp. 101
Application of the anti-fraud provisions of the federal securities lawsp. 102
Securities offering reformp. 103
Provision of informationp. 103
The Investment Company Act of 1940p. 104
The note offering - the offering circularp. 104
Important termsp. 104
ERISA considerationsp. 106
Other considerations regarding the proceeds and payment of interestp. 109
The risk analysisp. 110
Opinionsp. 110
Types of transactionsp. 110
Parametric, index and modeled loss transactionsp. 111
Indemnity transactionsp. 111
Conclusionp. 115
The Investor Perspective (Non-Life)p. 117
The creation of a sustainable and liquid marketp. 117
Creation of common terminologyp. 118
Risk analysisp. 119
Correlation with other investments in the portfoliop. 119
Relative valuep. 121
Valuation and liquidityp. 121
Key transaction features from the investor perspectivep. 122
Assessment of the underlying risks being securitisedp. 122
Risk assessment of the instrumentp. 124
Pricing and risk-return profilep. 125
Market evolution: the investor perspectivep. 127
Collateral arrangementsp. 127
Data transparencyp. 128
Exposure monitoringp. 129
Modelling rigourp. 129
ILS Portfolio Monitoring Systemsp. 131
Introductionp. 131
Completing the circlep. 131
'Square peg in a round hole?'p. 132
Miu - An ILS platform in a convergent spacep. 133
Overviewp. 133
Nuts and bolts - how the platform worksp. 133
Step by step - entering a contractp. 134
Portfolio analysisp. 134
RMS library of cat bond characterisationsp. 137
Motivation and objectivesp. 137
How is it done? A bird's eye viewp. 137
Apples to apples - a leap for the marketp. 138
Conclusionp. 138
The Evolution and Future of Reinsurance Sidecarsp. 141
A brief history of the brief history of sidecarsp. 142
Sidecar structuresp. 143
Basic structurep. 143
Market-facing sidecarp. 144
Non-market-facing sidecarp. 145
Capitalising sidecarsp. 146
How sidecars and catastrophe bonds are differentp. 147
The appeal of sidecarsp. 148
From a cedant/sponsor perspectivep. 148
From an investor perspectivep. 149
Structuring considerationsp. 149
The outlook for sidecarsp. 150
Conclusionp. 151
Case Study: A Cat Bond Transaction by SCOR (Atlas)p. 153
Introduction: SCOR's recent historyp. 153
Atlas III and IV: Backgroundp. 153
Atlas: Main characteristicsp. 155
Basis Riskp. 158
Resetp. 158
Gross upp. 158
Overlapp. 158
Synthetic coversp. 159
Total Return Swapp. 160
Conclusionp. 160
p. 161
Definition of eventsp. 161
Extension eventsp. 162
Case Study: Swiss Re's New Natural Catastrophe Protection Program (Vega)p. 163
A positive evolution of Swiss Re's ILS strategyp. 163
Swiss Re accesses multi-event natural catastrophe coveragep. 164
The first ILS to use a cash reserve account as credit enhancementp. 164
Innovation leads to more efficient protectionp. 165
Life Securitisationp. 167
General Features of Life Insurance-Linked Securitisationp. 169
Life insurer corporate and business structures, risks and productsp. 170
Mutual life officesp. 170
Proprietary life officesp. 171
Other forms of life officep. 173
Principal risks associated with life insurance businessp. 173
Principal product types and associated risksp. 176
Actors and their rolesp. 177
Sponsorp. 177
Investorsp. 179
Regulatorsp. 179
External professional advisersp. 179
Ratings agenciesp. 181
Monoline insurersp. 181
Liquidity providersp. 181
Swap providersp. 182
Othersp. 182
Processp. 182
Cedants' Perspectives on Life Securitisationp. 189
A cedant's perspective on life securitisationp. 191
Why Securitise?p. 191
Life ILS can be complexp. 194
Outlook for life ILSp. 198
A cedant's perspective on life securitisationp. 199
Key considerationsp. 199
Examples of securitisation opportunitiesp. 202
Differences between securitisation and reinsurancep. 205
Rating Methodologyp. 207
Fitch's approach to the rating processp. 207
Insurance risk analysisp. 208
Risk modellingp. 208
Ratings benchmarksp. 209
Analysis of sponsor and other counterpartiesp. 210
Surveillancep. 210
Zest: a VIF case studyp. 211
Referencesp. 212
Life Securitisation: Risk Modellingp. 213
Modelling of a catastrophic mortality transactionp. 213
Modelling of a VIF transactionp. 216
Life Insurance Securitisation: Legal Issuesp. 219
Monetisation of future cash flowsp. 219
Some background on monetisationp. 219
The market drivers of monetisationp. 220
Monetisation in the current climatep. 221
Some transaction structuresp. 221
Legal aspects of life insurance securitisation - some key featuresp. 222
Closed book/open bookp. 222
Unit-linked policies - not 'with profits' policiesp. 222
Risk transfer versus no transferp. 222
Warrantiesp. 222
Monoline wrap (payment obligation)p. 223
Recharacterisation riskp. 223
Some examples of value-in-force securitisation/monetisationp. 225
A classical VIF structure: Gracechurchp. 225
A private but reported transaction: Zestp. 226
Outlookp. 227
The Investor Perspective (Life)p. 229
Life insurance-linked risks and investor appetitep. 229
The role of the monolinesp. 229
Understanding the riskp. 230
Correlation with other investmentsp. 234
Relative valuep. 236
Valuation and liquidityp. 237
Key transaction features from the investor perspectivep. 237
Risk assessment of the instrumentp. 237
Pricing and risk-return profilep. 240
Market evolution: the investor perspectivep. 242
Longevity Securitisation: Specific Challenges and Transactionsp. 245
Mortality and longevity riskp. 245
A market for longevity riskp. 246
Potential sources of longevity risk for securitisationp. 246
Demand for longevity riskp. 247
Key structural aspects of longevity risk securitisationp. 248
Isolating longevity riskp. 248
Analysis of longevity risksp. 249
Longevity risk - legal explanationp. 250
Examples and legal aspects of transaction structuresp. 252
Some features of longevity riskp. 255
Model riskp. 255
Ratingsp. 258
Pricingp. 258
Longevity Risk Transfer: Indices and Capital Market Solutionsp. 261
The nature of longevity riskp. 262
The market for longevity risk transferp. 263
Hedgersp. 263
Investorsp. 265
Intermediariesp. 265
Importance of indices, tools and standardsp. 266
Longevity indicesp. 266
Trading and liquidityp. 268
Capital market instruments for longevity risk transferp. 268
Longevity bondp. 268
Survivor swapp. 269
q-forwardp. 269
Survivor forwardp. 271
Instruments and liquidityp. 272
Customised vs standardised longevity hedgesp. 273
Customised longevity hedgep. 273
Standardised index-based longevity hedgep. 273
Advantages and disadvantagesp. 274
Case study: customised longevity hedgep. 274
Implementing a standardised index-based longevity hedgep. 275
Liability sensitivity and hedge calibrationp. 276
Hedge effectiveness analysisp. 278
Conclusionsp. 280
Referencesp. 280
Case Study: A Cat Mortality Bond by AXA (OSIRIS)p. 283
Catastrophic pandemic riskp. 283
Considered risk transfer toolsp. 284
Detailed structurep. 285
Risk analysisp. 287
Modelling approachp. 287
Index Constructionp. 287
Investors' reactionp. 288
Spread behaviourp. 288
Next stepsp. 288
Referencep. 291
Case Study: Some Embedded Value and XXX Securitisationsp. 293
Embedded value securitisation - Avondale S.A.p. 295
XXX securitisationp. 299
Tax and Regulatory Considerationsp. 305
The UK Taxation Treatment of Insurance-Linked Securitiesp. 307
The Directive and the taxation of UK ISPVsp. 308
The implementation of the Directive in the UKp. 308
Implementation of the ISPV framework in the UKp. 308
UK tax treatment of ISPVsp. 310
Non-UK insurance special purpose vehiclesp. 315
Tax residence status of the issuerp. 316
Tax residence status of the issuer's agentsp. 317
Location and management of the issuer's assetsp. 318
Indirect taxes and withholding of income taxp. 320
Further readingp. 321
The US Federal Income Taxation Treatment of Insurance-Linked Securitiesp. 323
Avoiding US corporate income tax for the issuerp. 324
Overviewp. 324
Trade or business in the United Statesp. 325
Procedures followed by catastrophe bond issuers to avoid substantive business activities in the United Statesp. 326
Section 864(b)(2) safe harborp. 328
Withholding tax and excise taxp. 328
Overviewp. 328
Descriptions of insurance-linked instruments written on standard ISDA formsp. 330
Federal income tax definition of notional principal contractsp. 331
Put optionsp. 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: overviewp. 335
US investorsp. 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 instrumentp. 338
Foreign investorsp. 339
Notes that are treated as indebtedness for federal income tax purposesp. 339
Referencep. 339
Regulatory Issues and Solvency Capital Requirementsp. 341
Regulatory issues relevant for ILS sponsorsp. 341
Solvency capitalp. 341
Recognition of sponsors' claims against SPV as eligible assetsp. 342
Solvency Ip. 343
Overviewp. 343
Requirement to maintain a solvency marginp. 344
Structuring ILS under EU Directives to enhance solvency marginsp. 348
Solvency IIp. 351
Valuation of assets and liabilitiesp. 353
Determination of technical provisionsp. 353
Solvency capital requirementp. 354
Minimum capital requirementp. 358
Own fundsp. 359
Investmentsp. 360
Standard formula, solvency capital requirement (SCR)p. 361
Calculation of the basic solvency capital requirementp. 361
Calculation of the non-life underwriting risk modulep. 361
Calculation of the life underwriting risk modulep. 362
Calculation of the market risk modulep. 362
Indexp. 363
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