rené cotting, phd financial institutions solutions group - insurance international insurance...
TRANSCRIPT
René Cotting, PhDFinancial Institutions Solutions Group - Insurance
International Insurance SocietyBerlin, July 8-11, 2007
Growth Agenda for the Insurance Industry
A Capital Markets Perspective
2
Growth Agenda for the Insurance Industry
A Capital Markets’ Perspective:
1. Markets – size, growth and interaction
2. Innovations – recent & pending
3. Requirements – to facilitate growth
4. Conclusions
3
1. Insurance & Capital Markets – Areas of Interaction
Adapted from P. Shimpi, Integrating Corporate Risk Management
R/I:
XL / SL
QS /Sidecars
Credit Lines
Contingent Capital
Derivatives
Equity, Rates, FX, Commod., Inflation, Weather,…
Senior Debt
Subordinated Debt
Equity
Insurance Linked
Securities (Cat Bonds)
Risk Transferred Retained
Ca
pit
al
Off
-B/S
P
aid
-Up
risk
risk
CFO
RM
Risk-Capital MapHow can the Capital Markets supportYour Business?
Capital: Accelerate the B/SFlexible Capital Structures
RBC: Associates Risk with Capital and hence Cost
Applies to Economic, Regulatory and Signal Capital
Risk Transfer / Risk Management
4
1. Global Capital Markets – Size (matters…..)
Total Global Capital Markets Outstanding
Estimate2:
Equity $ 75’000 bn
Fixed Income $ 75’000 bn
Total $ 150’000 bn (100%)
MSCI Global Capital Markets Index1
$44’900 bn
Asset Segment Weight
Equity $25’800 bn
North America 28.5%
Europe 16.7%
Asia & Pacific 8.2%
Emerging Markets 4.1%
Total Equity 57.5%
Fixed Income $19’100 bn
Sovereign 22.1%
US 4.7%
Europe 8.6%
Japan 6.0%
Other 2.8%
Investment Grade Credit 18.7%
US 7.3%
US Mortgage Backed 6.1%
Europe 4.5%
Other 0.8%
High Yield 1.7%
Total Fixed Income 42,5%
Source: SIFMA
1: only liquid investable assets, as of March 20062: Extrapolation based on U.S. gross-up factors
Total FI27,700
U.S. Capital Markets Outstanding $ 49'500 bl as of March 31, 2007
21,800
4,4002,6002,400
6,600
2,400
4,000
5,300 Equity
Treasury
Federal Agency
Municipal
Mortgage Related
Asset-Backed
Money Market
Corporate
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1. Insurance Market Size
Global Insurance Premiums1
non-life $ 1’619 bn
Life $ 1’707 bn
Total $ 3’311 bn
Global Catastrophe Market2
Premium $12.9 bn
Limit $143 bn
(0.1%)
Capital Increase (following KRW)
Existing Companies $ 5.3 bn
Start-Ups $ 1.9 bn
Alternative Capacity2,3,4
ILS $ 28.0 bn
of which cat.
$ 10.3 bn
ILW $ 6.5 bn
Side Cars $ 5.1 bn
Private Placements ???
Total Alternative Insurance Capacity ≥$ 40 bn (0.027%)
1: OECD markets 2004, source: OECD2: 1/2007 figures, source: Guy Carpenter3: source: Swiss Re sigma4: source: LaneFinancial
Alternative Cat Capacity accounts for
>15% of Global Catastrophe Limits
6
ILS Outstanding
0
5
10
15
20
25
30
1996 1998 2000 2002 2004 2006
$ b
l
CreditMotorLiabilityCatastropheLife settlementExcess mortalityReg. XXXEV
1. Growth of Alternative Insurance Capacity
Life Risks securitized to date
XXX/AXXX regulatory reserves
Catastrophic Mortality
Embedded Value
P&C Risks securitized to date Natural Catastrophe
Big Four: US HU, US EQ, EU WS, JP EQ JP TY, Med EQ, TW EQ, Aus CY/EQ,
Mex EQ, UK river flood, …
Credit (Trade, R/I Recoverables) Liability Motor
Longevity conspicuously absent
Insurance Linked Securities (ILS)
20061 has been a banner year 60% of ILS is life related Still only 0.03% of Global FI Markets
Source: Swiss Re sigmaUpdated with company disclosures for full 2006
1: trend continued in 1H07
CAGR: 42%
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1. Impact on Reinsurance Market - Cycle is flattening
21192314
945
13
10
AndrewNorthridge WTC
Rita Wilma
Katrina
CharleyIvan
Rate Impact per Dollar Loss1 decreased significantly:
Andrew 92: 2.4% / $bn
WTC 01: 1.2% / $bn
KRW 05: 0.7% / $bn
Speed of Capital is increasing
Cycle Amplitude is flattening
Post-Loss Recuperation is no longer a viable strategy
1: indexed, not trended
2: Source: Swiss Re Sigma 2/07(liability and NFIP flood losses excluded)
3: Source: Lane Financial LLC Trade Notes
April 2007 (with data from Paragon)
55% / 23bn = 2.4% / $bn 1.2% / $bn
1985 1990 1995 2000 2005 1Q07
YoY Index Change (detrended)
+25%
+45%+55%
The eight largest global catastrophe insured losses 1970-2006, indexed, not trended2
Reinsurance Rate Changes3
0.7% / $bn
YoY Index Change
SidecarsILSStart-UpsRecapitalization
Loss
8
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2002 2004 2006 2008 Est.
$ b
l
Other
Insurance Companies
Investment Managers
Leveraged / hedge funds
Banks
CAGR: 81%
CAGR: 25%
CAGR: 9%
CAGR: 7%
1. Capital Market Comparables
Credit Default Swaps (CDS)
CDS = “credit insurance”
today the global CDS market exceeds the cash market
Mortgage Backed Securities (MBS)
Allowed banks to sell down risks previously held on B/S (de-risk & accelerate B/S)
Facilitated by Government Agencies
Acceptance criteria Standardization
Creation of secondary market
Guarantee timely payment to investors
Global CDS Market (Notional Amounts)
Source: Mellon / BBA
(U.S. only)
Source: SIFMA
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1. Private Equity Markets
Total PE capital raised: $ 800 bn
of which by top-50 PE firms: $ 551 bn
Cumulative buying power1: $ 4’000 bn
Global IPOs: $ 2’322 bn
Top-5 PE firms Capital Raised
1. The Carlyle Group $ 32.5 bn
2. Kohlberg Kravis Roberts $ 31.1 bn
3. Goldman Sachs Principal Investment Area$ 31.0 bn
4. The Blackstone Group2 $ 28.4 bn
5. TPG (Texas Pacific Group) $ 23.5 bn
Top-50 PE firms by Location
Insurance
Post KRW Sidecars raised $ 5.1 bn capital;
$ 3.6 bn of which equity
Corresponds to 0.45% of average annual
PE buying power
High Sidecar activity in 2006 abated in 2007
source: Dealogic / Private Equity International All data for the period 1.1.2002 – 18.4.2007
1: assumes 5-times leverage multiple
2: IPO on June 22, 2007
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11
5 1
U.S.
U.K.
WesternEuropeAustralia
10
A: Elimination of Credit Cliff in Catastrophe Bonds
2. Examples of Recent Innovations
A standard catastrophe bond gives investors and rating agencies no early default warning (digital credit cliff)
Cat bond rating ceiling of A and strong pricing compared to CDO/ABS market
Applying CDO technology to a basket of natural catastrophe perils1
– Decouples security rating from individual layer risk profile– Results in gradual rating migration rather than digital default
As a result, the Senior Tranche of Fremantle achieved AAA/Aa1 rating
1: Bay Haven, Fremantle, Gamut Re
2: Fitch/Moody’s rating
Mezzanine (Class B)BBB+/A3
Senior (Class A)AAA/Aa12
$33.375m Each Event
Event 9
Event 3
Event 8
Event 7
Event 6
Event 5
Event 4
Event 2
Event 1
Junior (Class C)BB-/Ba2
Region Peril Trigger
UK Windstorm Param.Europe Windstorm Param.
Japan Quake Param.
Japan Typhoon Param.
California Quake PCS
New Madrid Quake PCS
East Coast Hurricane PCS
Gulf States Hurricane PCS
Florida Hurricane PCSBy-pass Hurricane PCS
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B: Dynamic Hedging of Secondary Guarantees
Guaranteed Minimum Benefits (GMB) are value added guarantees embedded into U.S. style savings products such as Variable Annuities
A Guaranteed Minimum Death Benefit (GMDB) for example represents a mortality investment hybrid risk with sensitivity to
– Equity (delta, gamma, vega)
– Interest rates (rho)
– Realised mortality
– Persistency / policyholder behaviour
Dynamic hedging of complex guarantees with liquid, traded instruments (i.e. swaps, futures, options)
Requires periodic / frequent hedge adjustment
Net Market Risk Minimized
Hedging Activity prompted by introduction of new regulation (C-3 Phase II Market Risk Requirement Nov. 2005)
2. Examples of (not so) recent Innovations
Investment risks
Maturity
Account Value
NAV
GMAB
GMDB (ratchet)
Death Pay-off
Maturity Pay-off
Surrender Pay-off
Insurance risks
GMDB: Guaranteed Minimum Death Benefit
GMAB: Guaranteed Minimum Accumulation Benefit
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2. Examples of recent & pending Innovations
C: Regulatory Reserve Financing
(i.e. XXX / AXXX reserves)
Move from pure credit support (i.e. standard
5-7y LoCs) to mortality linked credit structures
as alternative to securitizations
Resulting credit risk is conditional upon
underperformance of underlying block (double
trigger)
Allows to secure capital support for much
longer tenors (e.g. 30y) for a similar pricing as
7y LoCs
Requires insurance (mortality / persistency)
as well as credit expertise
D: Longevity
(pending)
Not much securitization activity to date
Attempt to create liquid swap market
Difference in expectation between buyer and seller – in particular on tenor
Negative accounting arbitrage for corporate sponsors
Current FTSE 100 pension deficit at Dec.06 is £38bn from £75bn at Dec.051
1850 1875 1900 1925 1950 1975 20000
10
20
30
40
50
60
70
80
year of death
age
Mortality Ratesqx (U.K. Males)
?
1: source: Deloitte, FTSE 100 went up +12% during 2006
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3. Requirements for Capital Markets Solutions Growth
1. Risk Standardization (I) – Documentation Insurance policy / reinsurance treaty vs. ISDA Master & Schedule Lack of standardization introduces basis risk
2. Risk Standardization (II) – Natural Catastrophe Indices Indices create liquidity & reduce transaction costs
– PCS-style market loss reporting for non-U.S. perils
– Longevity Indices (relevant and independent)
3. Market Consistent Valuation of Risks & Reserves Reduces arbitrage / creates level playing field Facilitates economically motivated hedging decisions
4. Insurance Rates remain at technical levels Capital is not locked into insurance sector Will be reallocated quickly, if return expectations no longer meet expectations
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3. Requirements Growth (cont.)
5. Further educate & develop investor base
Reach for investors beyond cat. / hedge fund world
CDO / ABS investors
Institutional investors
6. Continuous flow of new issues
Allowing investors to build portfolio
Economy of scales
15
4. Conclusions
Capital Markets Solutions are well established by now But more work needs to be done Self-enforcing process (supply, liquidity, demand, granularity of hedging indices) We are only at the beginning
Basis Risk as an Opportunity for Risk Aggregators Wholesale risk transfer to capital markets based on parametric / industry triggers Basis risk fully priced in and retained where expertise is highest Likely to become a lesser issue as markets mature
Longevity market expected to explode Global Correlation of Mortality Improvement greatly reduces Diversification Benefits Size of Exposure: $ 19’000 bn of global pension assets1 (13%) Set-up of dedicated pension / closed block buy-out firms
1: OECD, FIAP, IFSL estimates, Dec. 2004
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4. Conclusions (cont.)
Paradigm Change
From Claims experience driven capital level and variable rates (recuperation)
To Pro- and retroactively managed capital level and stable rates
…And ultimately to
A Fee-based rather than Risk-based Insurance Business Model
Based on Sourcing, Characterizing, Packaging and Selling of Insurance Risks
With the majority of the Risks transferred to investors
Similar to how banks manage loans, mortgages and credit card debt