Insurance Linked Securities : Innovation in Risk Transfer

Dr Pierre Wiart Senior Underwriter, Insurance Australia Group Email: [email protected] AGENDA

1. ILS and Reinsurance Review – Plenty of Capital ?

2. Cat Bond Structure: A Story of Two Tales

3. ILS and Cat Modeling – the Road to Innovation

4. Recent Innovations and Potential for Australia

Disclaimer This presentation has been prepared for the Reinsurance Discussion Group. The content of this presentation represents the sole opinion of the author, and does not illustrate, represent, preview any of IAG’s views. Part 1

ILS and Reinsurance Review Plenty of Capital ? ILS & ALTERNATIVE CAPITAL WHAT ’S THE FUSS ?

• 2017 : $78 bn (AonBenfield Analytics ) • Alternative Capital represents 13% of reinsurance capacity • As of 2017, Cat Bonds represent $26 bn, Collateralised $40 bn , ILWs $4bn and Sidecars $8 bn CAT BOND AND SECURITIES MARKET

• Cat Bonds are structured for 3 to 5 years. • Securities exchanged on secondary market • Better to look at the outstanding • Cat Bonds currently $26 bn of which $8.57 bn will mature in 2017 TOP 10 ILS F UND MANAGERS

AuM more than 20bn June 2013 to Jan 2017 $52.4 bn Jan-17 1997 Jun-16 Jan-16 10.2 Jun-15 2003 9 Jan-15

2001 Jun-14 7.5 2001 Jan-14 6.5 2012 $32 bn 2010 Jun-13 5.4 2005 5.2 5.1 2008 2006 2009 4.3 4.3 4.1 3.5 3.1 2.8 3 3 1.8 2 1.4 1.2 0.8 PLENTY OF CAPITAL ?

Potential loss distribution for 1-in-200-year US hurricane (USD bn) - Source Deutsche Bank 2016

USD bn

Source: Deutsche Bank According to these figures :  $12bn ILS loss wipes out 45% of the outstanding $26bn Cat Bonds  $20bn Alternative Capital wipes out 50% of the $40bn collateralised deals Part 2

Cat Bonds – a Story of Two Tales MultiCat Mexico - Class C - 2012 MULTI CAT MEXICO -CLASS C - 2012

• Issuer / SPV: MultiCat Mexico Ltd. (Series 2012-1) • Cedent / Sponsor (Fronting): Fund for Natural Disasters of Mexico (FONDEN (Swiss Re) • Placement / structuring agent/s: Swiss Re Capital Markets, Goldman Sachs and Munich Re are co-lead structurers. Swiss Re Capital Markets and Goldman Sachs are joint bookrunners • Risk modelling / calculation agents: AIR Worldwide • Risks / Perils covered: Mexico hurricane • Size: Class C $100m ($315m All Classes) • Trigger type: Parametric • Ratings: S&P: Class C - 'B-' • Date of issue: Oct 2012 • Date of maturity : 04/12/2015 • Coupon / pricing yield Class C: 7.50% • How does it work?

MultiCat Mexico Class C <932 mb and >920 mb < 920 mb Trigger Central Pressure Principal Amount Payment 50% 100% MULTI CAT C VS .

• Hurricane Odile : September 10 - 19 , 2014 on the Pacific Coast of Mexico hitting the Baja California peninsula • At its peak, on September 14 , Hurricane Odile reached Category 4 status with 220 km/h wind speed (1-min sustained) and a bottom pressure of 918 mbar • Hurricane Odile landed on September 15 on the southern tip of Baja California near Cabo San Lucas • The MultiCat Mexico 2012 catastrophe bond features a parametric trigger. Central pressure of the storm within the parametric box must fall between 932mb and 920mb to result in a 50% loss of principal, or below 920mb to cause a 100% loss. HURRICANE ODILE VS . MULTI CAT MEXICO

Hurricane Cat 3 Year (since 1842) Wind spead (at landfall) Landfall Olivia 1967 205 km/h La Paz (North) Kiko 1989 195 km/h San Jose del Cabo (North) Odile 2014 200 km/h Cabo San Lucas

941 mb

Class C Zone ? 930 mb

MultiCat Mexico Class C <932 mb and >920 mb < 920 mb Trigger Central Pressure Principal Amount Payment 50% 100% MULTI CAT C VS . HURRICANE ODILE

HU ODILE September 15, 2014 Price Evolution after HU Odile (Source Swiss Re ) • On September 19, the price felt to 52.38 (its 110 lowest price) • For three months the outcome of the bond was 100 unclear as 90 • On December 23, AIR (the calculation agent) reported that the hurricane’s central pressure 80 was not low enough to trigger the notes when Odile moved into the parametric trigger zone 70 • Mark-to-Market impact 60 Ask • Reduction of 50% of the price (anticipating a Bid reduction of 50% of the principal) 50 • On December 24, price back to 100.99 40

30

A YEAR LATER ….. HURRICANE PATRICIA VS . MULTI CAT MEXICO

In contrast: • A year later, in mid October, the 24 th named storm of the season, HU Patricia, developed South of Mexico • Patricia grew from a tropical storm to a Category 5 hurricane in just 24 hours—a near-record pace • On October 23, the hurricane achieved its record peak intensity with maximum sustained winds of 215 mph (345 km/h) • Later the HU Patricia made landfall near Cuixmala, , with winds of 150 mph (240 km/h), becoming the strongest landfalling HU on record on the Pacific Coast of Mexico HU P ATRICIA : A FREAK EVENT ?

Puerto Vallacarta

Manzanillo

image credit: Michael Lowry, The Weather Channel

Image credit: Patrick Marsh, @pmarshwx.Pierre Wiart - Convergence Partners Pty Ltd NOAA Report issued on 04 Feb 2015

“Patricia made landfall around 2300 UTC along the coast of the Mexican state of Jalisco near Playa Cuixmala, about 45 n mi west-northwest of Manzanillo. Operationally, Patricia was assessed to have been of category 5 intensity with a landfall pressure of 920 mb, but a post analysis of additional data obtained later suggests that the hurricane had weakened more rapidly . . . A minimum central pressure of 932 mb at landfall is inferred from these data, with the uncertainty of this value likely on the order of 2-3 mb.” -> 50% loss on MultiCat C

• According to Swiss Re Sigma 2014, HU Odile insured losses were USD 1.7 billion, making Odile the second largest insured loss event ever in Mexico, after 2005 (USD 2.1 billion). • In contrast, HU Patricia insured loss is around $200m if not less MULTI CAT PRICE EVOLUTION NOV 2015

Traded

26/10/2015 1MM+ @ 4.30 05/11/2015 1MM+ @ 9.50 06/11/2015 1MM+ @ 20.25 10/11/2015 1MM+ @20.25

Source: Trade Reporting and Compliance Engine (TRACE) – http://www.finra.org/ CAT BONDS TRIGGERED

 Since 1996, hundreds of cat bond deals, natural disasters have triggered fewer than six and only two have produced litigation or arbitration  Over $80bn of cumulative risk have been issue – Muteki Ltd., sponsored by Japanese agricultural insurance cooperative Zenkyoren Ltd., which paid a $300 million total loss after the March 2011 Tohoku earthquake and tsunami – Mariah Re Ltd., sponsored by American Family Mutual Insurance Co. of Madison, Wisconsin, which suffered total losses on two $100 million bond issues after severe Hail Storms struck the Midwest in 2011 – Kamp Re 2005 Ltd, sponsored by Zurich American Insurance Corp., which paid $144 million of its $190 million in principal on losses from Hurricane Katrina – Avalon Re Ltd., sponsored by Bermuda-based Oil Casualty Insurance Ltd., which lost $12.7 million of the $135 million in principal on a junior tranche of notes after the 2007 Consolidated Edison steam pipe explosion in New York – MultiCat Re 2012, sponsored by Fonden Mexico, paid $50m as 50% of 100m Class C tranche – Gator Re 2014, sponsored by American Strategic Insurance Group, aggregate indemnity, paid $35m out of $200m note.

 Less than $1bn have been paid

Page 17/15 Part 3

ILS and Cat Modeling: the Road to Innovation ILS AND CAT MODELING

• Pricing traditional reinsurance contracts relies often on multi models and actuarial approach • Cat Bonds (144a) are priced on one model … • Cat bond lite (Reg D) and private placement are priced on discretionary evaluation …

• Collaterised placement are a mix of the above… • 3 Main Firms but a lot a new independent companies CAT BOND ISSUANCES VS . MODELING AGENT

Modeling undisclosed as not required: Reg D, Private Deals, Club Cat Bond, Securitization of ILWs etc CAT BOND ISSUANCES VS . MODELLING AGENT AIR Issuancese.g. US Hurricane Risk And US All perils • Cranberry Re (MA Winds), Long point Re (Northeast WS)  Single State (Florida, Northeast, Gulf) • Pelican Re series (LA Hurricane)  Combined US Wind / EQ (ex New Madrid) • Citrus Re Series, Everglades Re Series, Armor (FL Hurricane) • Residential Re Series (USAA US All perils), Caelus Re (Nationwide AP), Sanders Re series (Allstate US AP ex FL) Combined WW regions • Successor Series , Queens Street Series (Munich Re US  Combined US and EU Wind Wind EU Wind) Galileo Re (Catlin US wind Can EQ EU  Japan TY and/or EQ Wind) … • Kizuna Re series (TokioMarine JP EQ), Nakama Re series (Zenkyoren JP EQ), Azora Re (Sompo JP TY) … RMS Issuances e.g. All NA perils bundled • Merna Re Series (State Farm US EQ New Madrid)  US EQ (New Madrid) • Tradewynd Re (AIG US, CB, MX, Can All perils)  North America bundle • East Lane Re Series (Chubb US All perils) • VenTerra Re (QBE US EQ AU EQ AU CY) … New perils  Turkey EQ • Bosphorus 1 Re (Turkish EQ Pool)  UK Flood • Blue Wings Ltd (Allianz UK Flood)  Storm Surge (NY) • MetroCat Re (MTA surge NY) … Other than Cat • Benu Capital (Axa Global Life) - Atlas IX Capital (Scor  Extreme mortality (US, UK, FR, JP) Global Life) - Mythen Re and Vita Capital (Swiss Re)  Worker Compensation extreme mortality US, UK, FR, JP • Golden State Re Series (CA State Workers Compensation) STUDY BY TRADING RISK ON SYNTHETIC ‘F LORIDA RE’ PORTFOLIO

Expected loss by Peril by Model Range of Expected Loss by Model

16 8 14 7 6 2.2x 12 5 10 4 8 3 6 2 1.7x 4 1 2 0 0 AIR Eqecat RMS AIR AIR Eqecat Eqecat RMS RMS (base) (sensitivity) (base) (sensitivity) (base) (sensitivity) Wind Storm Leakage Exhaustion probability Expected Loss Attachment probability Demand Surge Sensitivity Theoretical ‘Florida Re’ cat bond based on annual aggregate structure (to emphasize) $10bn bond

All graphs: source Trading Risk Part 4

Recent Innovations and Potential for Australia INNOVATION -NEW PERIL CAT BONDS 2012 & 2015

 Metropolitan Transport Authority (MTA) suffered a $4.8 Billion Loss from Sandy  MTA has a $500 million insurance protection for Wind and Fire (no Surge) – cost $46 million  "For New York City, it's once every 175 years for a major hurricane and once every 25 years for a hurricane.” James Franklin, NHC, NOAA

MetroCat Re 2012-1A PennUnion Re 2015-1A (SPI Bermuda) (SPI Bermuda) Maturity 3 years 3 years Sponsor MTA Amtrak Coupon MMY+ 450bps MMY+ 450bps Expected Loss 171 bps 197 bps

Perils Covered Storm Surge NYC Storm Surge NYC + DE Wind + EQ Northeast Calculating Agent RMS RMS Trigger Type Parametric Parametric Principal Offer/Placed $125 m / $200m $200m / $275m INNOVATION -HORSE CAPITAL 1 DAC 2016

Horse Capital I DAC (Ireland)  Sponsor : Assicurazioni Generali  Placed by Willis Capital Market & Securities  First ever 144A Insurance Linked Security (ILS) placement on MTPL loss ratio (‘CTP’)  Risk Modeling Agency: Milliman  Structure as Indemnity based on Loss Ratio by Countries including Austria, Czech Republic, France, Germany, Italy, Spain and Switzerland  3 tranches of notes, each in the amount of €85 million - total amount of €255 million (up <40% than initial €180 million). INNOVATION -OPERATIONAL RE 2016

Operational Re Ltd.  Sponsor : Credit Suisse via Zurich Insurance (fronting)  First ever 144A Insurance Linked Security (ILS) placement on Operational Risk including:  BI due to IT failure  Compliance issues  Accounting and documentary errors  Fraudulent behaviour of employees and third-parties  Unauthorised employee activity (e.g. rogue trading)  Risk Modeling Agency: Milliman  Aggregate cover  Modeling remained the biggest hurdle for investors  Targeted CHF 630 million, placed CHF 220 million  PB of modelling and correlation with CS ‘s stock AUSTRALIA - POTENTIAL FOR ILS ?

Securities (144A, Reg D, Private Cat Bonds) that involved Australia:  Australis Ltd 1&2 (2006 & 2007) - $100m & $50m  Vita Capital VI Ltd (2015-1)– AUS, CAN, UK mortality index - $100m

 VenTerra Re Ltd (Series 2013-1) - $250m  ? Resilience Re (Series 1712) Willis Re “Club Cat Bond” - $187m

 Queens Street IX Re Ltd (2014-1) - $100m  Queens Street X Re (2015) - $100m  Queens Street XI Re dac (2015) - $100m

 Private note (zero-coupon) – Rewire (2015 & 2016) - $25m

 Galilei Re Ltd (2016-1) & (2017-1) - 2x $ 500m  First used of PERILS index losses for Australia % Total Loss

6%

30% AUSTRALIA: POTENTIAL FOR ILS ? 22%

Australia Industry Modelled Losses (1/1/2015) 10% 500+ 15% 250-500 16% 200-250

100-200 Past Industry Losses (1967- 2014) 50-100

20-50

10-20

3-10

Return Period of Layer (Years) Layer of Period Return 1-3

0-1

$0m $50m $100m $150m $200m $250m $300m $350m $400m $450m Average Annual Loss (AUD) Source : COMBUS ILS I NVESTORS FROM AUSTRALIA

• Mostly SuperAnnuation Funds • MLC switch from Nephila to AlphaCat >50m in 2015 • NZ Super - $53m to Elementum & 210m Leadenhall Capital Partners (tot 2.4 % of NZ$30.1bn) • Future Fund $100m Elementum 2015 + $? Kiskadee Hiscox • QIC large amount but not public … • AMP with Nephila $50m • First State Super with Nephila • Probably >2bn from Australian/NZ investors ILS PERFORMANCE FOR INVESTORS Questions

Dr Pierre Wiart

Email: [email protected]