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Introduction to … A ROLE FOR ACTUARIES IN REINSURANCE AND CAPITAL MARKET CONVERGENCE CASE Fall Meeting – October 2015 Achille Sime, FIAF FSA MAAA CERA CEO of SL FINANCIAL, Inc. [email protected] CONFIDENTIAL Disclaimer This presentation was prepared by SL FINANCIAL for use in marketing or industry presentations. Information contained herein is believed to be reliable, but SL FINANCIAL does not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. CONFIDENTIAL Table of Contents Insurance-Linked Securities (“ILS”) Universe • Introduction • Market Size • Types of Transaction Impact on Reinsurance Industry • Disruptive Innovation • Evolving Business Models Actuarial Involvement in ILS CONFIDENTIAL ILS Universe: Introduction What is Alternative Risk Transfer (“ART”)? • Use of techniques other than traditional (re)insurance to protect risk- bearing entities from risk of loss • ART market began in the 1990’s in effort to expand insurers’ ability to transfer peak insurance risks • Objective: attract non-traditional capital willing & able to absorb insurance risk uncorrelated to existing portfolios while seeking favorable returns What is Insurance-Linked Securities (“ILS”)? • Financial instruments whose values driven by insurance loss events • Generic term referring to transactions in which insurance risks are transformed into transparent and tradable capital market products • Also referred to as Alternative (Capital Market) Reinsurance CONFIDENTIAL ILS Universe: Market Size ILS market expected to reach 20% of global reinsurance capacity in 2015 Catastrophe bonds and ILS cumulative issuance by year 70,000 60,000 50,000 40,000 30,000 Issued $m Issued 20,000 10,000 - Source: www.artemis.bm Deal Directory CONFIDENTIAL ILS Universe: Market Volume (Non-life) Non-life alternative reinsurance has increased 28% since year-end 2013 to US$63.8B 70 63.8 Collateralized Reinsurance Collateralized ILW Sidecars Cat Bonds 60 50 49.7 44.0 40 30 27.5 Issued $BIssued 23.6 21.8 22.3 18.9 20 17.1 10.5 8.4 10 7.4 5.4 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Aon Benfield Securities, Inc. As of December 31, 2014 CONFIDENTIAL ILS Universe: Types of Transaction A risk-linked debt security that transfers a Catastrophe Bonds specified form of catastrophe risk from a sponsor •High Layers company to investors •Low EL* •Low ROL* •High Liquidity A fully collateralized Industry Loss Warranty, Collateralized ILW’s which is a contract that pays out for events greater than a pre-defined loss threshold •Working Collateralized A reinsurance agreement that is fully collateralized, Layers Reinsurance typically by unrated third party capital •Low Liquidity A limited purpose company created to assume a •Retention Sidecars pre-defined portion of insurance policies from •High EL •High ROL an issuing insurance carrier * EL: Expected Loss ROL: Rate-on-Line •Low Liquidity CONFIDENTIAL ILS Universe: Catastrophe Bond Structure Special Purpose Vehicle (“SPV”) established to write a reinsurance Sponsor agreement (Re)insurance Co. • Entity exists solely to write the specific transaction Reinsurance Ceded Contract Premium Investors purchase bonds issued by the SPV Remaining Principal Issuer: • Investors receive interest income on the Investors Special Purpose Note Proceeds Vehicle (SPV) invested funds plus a premium (interest Principal At-Risk spread) for the risk assumed Variable Rate Coupon Notes Collateral • Funds raised collateralize the reinsurance (LIBOR + Spread) Trust Account agreement (i.e. limited credit risk) No Loss Events • Principal repaid to investors with interest Collateral Loss Events Management • Insured (sponsor) has transferred Options: catastrophe risk and receives loss a. High Quality Securities payment from the SPV b. Level of Investment Risk • Insufficient funds in the SPV to fully repay investors (i.e. full or partial default) CONFIDENTIAL ILS Universe: Collateralized Re Structure Special Purpose Vehicle (“SPV”) Ceded Premium established to transform insurance Sponsor Reinsurance Co. risks into capital market products (ceding co.) Reinsurance Contract (cell) • Typically licensed reinsurance company Counterparty with segregated account (“cell”) structure Contract Some advantages of cell structure: Remaining Funds • Less expansive than separate reinsurance Transformer: Special Purpose • Investors are non-voting shareholders Preferred Shares Vehicle (SPV) • Easier to unwind than stand-alone Investors company Collateral Dividends Trust Account Investors purchase non-voting preferred shares in the SPV • Funds raised collateralize the reinsurance agreement (i.e. no credit risk) Collateral • Investors receive dividends and remaining Management funds Options: • Allow direct investment into (re)insurance a. High Quality Securities b. Level of Investment Risk CONFIDENTIAL ILS Universe: Sidecars Equity Proceeds Holding company own 100% Equity Sidecar Dividends of the sidecar Investors Holdings • Capital structure typically include Security Interest in Equity Dividends Equity and Debt Shares Proceeds Sponsor buy reinsurance Loan Proceeds Sidecar Reinsurance Co. coverage Debt Investors Interests • Common for property and marine Collateral catastrophe risks Trust Account • Usually via a quota share Ceded Reinsurance reinsurance agreement Premium Contract • Receives commissions and fees (override and profit commission) Sponsor (Ceding Co.) • transaction typically has a limited lifespan CONFIDENTIAL Impact on Reinsurance: Disruptive Innovation Traditional reinsurance employs leverage • Reinsurers write policies whose losses are multiples of capital in balance sheets (“levered” balance sheets) • Leverage is accepted as part of business plan through diversification, risk management and credit rating Securitization eliminates leverage via full collateralization • Securitized risk hold cash and liquid securities equal to full limit of coverage • Thus reduces credit risk and makes liquid trading possible At simplest insurance securitization is change in capital structure: • From levered to unlevered (collateralized) balance sheet • From managing to hedging the risks CONFIDENTIAL Impact on Reinsurance: Evolving Business Models Evolving Business Models Key Risk Main Attributes Strategies Superior scale: globally big and Underwriting Capital and pricing efficiency knowledgeable Nimble innovator: uses analytics and Underwriting Platform flexibility and superior customer expertise understanding Llyod’s: combines depth and breadth Underwriting Creativity and innovation within small with expertise structure & global licenses Hedge-fund Re: accumulates (large) Asset Careful targeted risk selection with low stable funds to deliver superior volatility investment returns Risk transformer: specialist capital Fee income Channel investments into reinsurance market funds while providing capital efficiency & transparency Direct: partners with client to provide Underwriting Provides cost-efficient capital market targeted capital market protection protection against discrete risks Source: PwC Reinsurance 2020 & personal experience CONFIDENTIAL Actuarial Involvement in ILS Factors influencing actuarial involvement in ILS: • Transparency: Net Asset Value (“NAV”) published on monthly basis • Independence: Investors’ demand for independent third-party review • Credit rating agencies (“CRA”) and regulators prospective: o Assessors of creditworthiness and policyholders security o CRA used in structured finance to rate but also advise on structure o Actuarial work products is KEY rating factors (e.g. ratemaking and reserving) NAV is an assessment of fund’s Fair Value (“FV”) • 퐹푉 푡 ≈ 퐶표푙푙푎푡푒푟푎푙 + 푃푟푒푚푖푢푚 − 푃 푡 퐹푉 퐴푠푠푒푡푠 퐹푉 퐿푖푎푏푖푙푖푡푖푒푠 • 푃 푡 is premium that rational risk taker charge at t to assume all risks o 푃 푡 ≈ 퐿표푎푑푖푛푔 푡 ∗ 퐸 푋|퐿(푡) with 푃 0 = 푃푟푒푚푖푢푚 o 퐿 푡 = 푈푙푡푖푚푎푡푒 푙표푠푠 표푛 푒푎푟푛푒푑 푒푥푝표푠푢푟푒 CONFIDENTIAL Actuarial Involvement in ILS (cont.) Summary of current actuarial involvement in ILS • Actuarial risk analysis and pricing at inception • Revenue recognition according to seasonal earning of premium • Actuarial loss reserving related to estimating 퐿(푡) • Actuarial pricing related to estimating 푃(푡) • Portfolio risk management (e.g. track UW guidelines or risk metrics) • Collateral release and commutation (e.g. procedure for establishment and run-off of reserves) • Service provider (e.g. loss reserve specialist, calculation agent, peril modeler, etc.) • Third party valuation review • Education (…) CONFIDENTIAL Actuarial Involvement in ILS (cont.) Summary of current actuarial involvement in ILS • Financial analysis & reporting • Traditional actuarial loss reserving • Traditional actuarial pricing & modeling Some actuarial consideration in ILS valuations • Premium Estimate o Modeled vs. Un-modeled o Seasonality earnings o Remodeling after loss occurs & consideration for aggregate XOL contracts • Claims Estimate o Timing of recognition (expected, actual or modeled) o Attritional vs. Catastrophe o Reserving process and governance issues QUESTIONS? http://www.sl-financial.com.
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