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					BRAVE Partners LLP: Insurance Linked Securities – Cats and dogs                                        2009


        Insurance Linked Securities: Cats and
        dogs
        BRAVE Partners

        Dr. No had a white cat. Hank Greenberg is reputed to have had a small white dog called Snowball. Of
        course there is no connection, but in the insurance securitisation market, it is interesting that the only
        P&C business that is securitised is property catastrophe, or cat, risk. A few other risks have been
        securitised, namely auto insurance and third party liability. These deals have turned out to be a dog for
        someone.


XS loss property catastrophe               Cats – that is cat bonds
reinsurance has become a staple of         XS loss property catastrophe reinsurance has become a staple of the
the securitisation markets. The            securitisation markets. The business line has a number of features
business line has a number of              that make it readily securitised. In particular:
features that make it readily
                                                   A clear limit so that the total loss is well defined.
securitised. In particular:
                                                       o This means that investors know exactly how much is
    A clear limit so that the total                        at risk.
    loss is well defined.                          A short risk period (1yr) and a short tail (3yr max).
     o This means that investors                       o Investors know their gains and losses and have their
         know exactly how much is                          investment returned quickly.
                                                   Potential for high premiums for more risky tranches
         at risk.
                                                       o A natural fit for high yield credit investors.
    A short risk period (1yr) and a
    short tail (3yr max).                  The cat bond has become a staple in the alternative (usually to
     o Investors know their gains          credit) investment arena.
         and losses and have their
         investment        returned        In addition to property catastrophe there is a small, but well
                                           followed market in cat mortality bonds. These bonds lose principal if
         quickly.
                                           mortality rates exceed a certain index, or projection, by more than a
    Potential for high premiums
                                           defined percentage. For example, a tranche of a bond might lose
    for more risky tranches
                                           principal if the realised US mortality rates exceed the actuarial
     o A natural fit for high yield
                                           expectations by more than 15% - ie a mortality of 115% of the
         credit investors.
                                           actuarial rate.




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BRAVE Partners LLP: Insurance Linked Securities – Cats and dogs                                           2009

         Whilst mortality rates under normal conditions are extremely stable in the short term, the impact of
         disruptions like the current swine ‘flu pandemic are difficult to predict.

         Dogs – that is non-cat securitisation
         Securitising other insurance risks has been done, but often the transactions have not worked effectively
         for one party or another.

         Golden Goal
         The one non-cat securitisation that stands out as a winner was the Golden Goal deal for FIFA which
         protected against event cancellations at the 2006 World Cup. That, of course, would be the World Cup
         to which other nations get invited (for the Americans in the readership).

         Motor (Auto) securitization
         Axa and our friends at CDC IXIS did put together an interesting securitization of a motor insurance book.
         The senior tranches were popular and worked well. The equity is reputed to have been retained within
         the sponsor’s group which meant that the sponsor could not obtain any regulatory capital relief.

        The thorny issue, which remains open, is that losses on the bond were defined in terms of the loss ratio
                                         of the underlying book of motor business. The loss ratio can increase
The thorny issue, which remains          for two reasons: i) claims increase or; ii) premiums are reduced. An
open, is that losses on the bond         equity investor in the structure is exposed to a price war between
were defined in terms of the loss        auto insurers. The transaction is not a clean insurance risk, it has
ratio of the underlying book of          elements of business risk which mean that it would work better in a
motor business. The loss ratio can       private equity environment where the investors are more familiar
                                         with, and willing to take, business risks.
increase for two reasons: i) claims
increase or; ii) premiums are               At BRAVE Partners we believe that it is easy to be critical and much
reduced. An equity investor in the          tougher to pioneer. The firm applauds Axa and IXIS for the
structure is exposed to a price war         transaction which definitely set the standard in that space. Years
between auto insurers. The                  after the deal, no one appears to have had a better idea.
transaction is not a clean insurance
                                            Third party liability
risk, it has elements of business risk
                                            Avalon Re was a cat bond sponsored by the OIL Casualty Insurance
which mean that it would work
                                            Limited (OCIL). OCIL’s sister company OIL is Oil Insurance Limited. The
better in a private equity
                                            two companies are captives for the energy industry – with OCIL
environment where the investors
                                            writing the casualty, or liability, lines.
are more familiar with, and willing
to take, business risks.                        Avalon Re was a cat bond that was exposed to large claims at OCIL.
                                                The bond principal was at risk to an accumulation of events. An event
                                                was defined as something like a $150m OCIL insured loss. OCIL kept
                                                the risk of the first three events and then the bonds took the next
         losses; class C first; then class B; and finally class A.

         The following extracts from a Reuters report on S&P actions summarises the current status of Avalon Re:




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BRAVE Partners LLP: Insurance Linked Securities – Cats and dogs                                            2009

          They were originally due to mature on June 6, 2008, but were extended after a July 2007 steam pipe
         explosion in New York pushed estimated losses to ceding insurer Oil Casualty Insurance Ltd (OCIL) close
                                       to the level that would trigger the bond.

         Under the terms of the reinsurance agreement between Avalon Re and Bermuda-based OCIL, which is
           rated BBB+ by S&P, the notes can be extended for up to eight consecutive three-month periods.

        S&P downgraded the Class C notes in April 2008 after receiving notification that the steam pipe explosion
                            would be a covered event under the reinsurance agreement.

        "Given these loss amounts, the Class C notes will likely incur a principal loss. The Class B notes, given the
                current status of the claims, do not appear to be at risk of a loss in principal," S&P said.

         "However, there are currently two additional monitored claims, the
         first related to a spill at a Lake Charles oil refinery and the second to   “I remember one of the credit
                         claims involving exposure to lead paint."                   traders at my then current
        Lesson in cat bond investing                                                 employer proudly telling me how
        BRAVE Partner Christopher Cloke-Browne recalls: “I remember one of           he has sniffed out this great bond;
        the credit traders at my then current employer proudly telling me            Avalon Re. I listened to the outline
        how he has sniffed out this great bond; Avalon Re. I listened to the         description, which is much the
        outline description, which is much the same as the one given here.           same as the one given here. ‘Don’t
        ‘Don’t you think that a $150m loss in the global oil industry is a           you think that a $150m loss in the
        reasonably common event?’ I asked him. I got a long description of           global oil industry is a reasonably
        how it was not really like that and even if a rig blew up, it would not      common event?’ I asked him. I got a
        necessarily trigger an event. My suspicions were confirmed later. At         long description of how it was not
        the time, I was working on a deal with a broker who is highly familiar       really like that and even if a rig
        with the OCIL program. When I mentioned that I had found a trader            blew up, it would not necessarily
        who owned Avalon Re, he just shook my hand, looked me in the eye             trigger an event. My suspicions
        and wished the trader luck.”                                                 were confirmed later. At the time, I
        BRAVE Partners suggest a simple rule for investing in cat bonds: do          was working on a deal with a
        not underwrite without an experienced underwriter. Katrina and Ike           broker who is highly familiar with
        have shown that even the risks of a property catastrophe XL loss             the OCIL program. When I
        bond are not as straightforward as the models might suggest.                 mentioned that I had found a
                                                                                     trader who owned Avalon Re, he
                                                                                     just shook my hand, looked me in
        Opportunities                                                                the eye and wished the trader luck.”
        The credit crunch has created opportunities in the insurance risk
        asset class. AIG, Swiss Re and XL Capital are retrenching. The               Christopher Cloke-Browne
        managements at several other public companies are trimming                   Managing Partner
        capacity in apparently riskier lines, especially where losses are            BRAVE Partners LLP
        showing up. Certain markets appear to have rising demand and




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BRAVE Partners LLP: Insurance Linked Securities – Cats and dogs                                        2009

        falling capacity. BRAVE Partners believes that these are the               • Property catastrophe XS loss
        interesting markets                                                          reinsurance has become the
                                                                                     staple of the cat bond market.
        BRAVE Partners’ experience                                                 • The characteristics of this
        Structuring a sidecar for casualty risks will take some creativity.          business line make it a natural fit
        Casualty business is not such a natural fit for investors in capital, in     for capital markets.
        particular credit, markets as is natural catastrophe XL loss. Pure         • Attempts at securitising other
                                                                                     insurance risks have been less
        casualty business:
                                                                                     successful for both sponsor and
                Has no upper bound to a loss.                                        investors.
                    o Less certainty on the exposure level for a capital
                        markets investor.                                          • BRAVE Partners LLP can advise
                                                                                     both investors and issuers on the
                Has a longer tail on the claims. The Avalon Re bond shows this
                                                                                     optimal structures to transfer the
                as events are still being analysed to establish liability months
                                                                                     risk of other insurance business
                after the bond maturity.                                             lines to investors.
                    o Harder to keep the bond to shorter maturities.               • The BRAVE partners have a track
                        Investors, as with Avalon Re, have to wait before their      record of constructing innovative
                        investment result is known.                                  structures that work for both
                Has absolute premiums that have not been as high.                    issuer and investor.
                    o Cat bonds could not achieve the target returns of high
                        yield investors.                                           enquiries@bravepartners.com
        Market conditions are shifting. Returns in certain casualty lines are      www.bravepartners.com
        looking attractive, even to high yield investors and even in stressed
        credit markets. The other issues are surmountable with some
        creativity. BRAVE Partners addressed many similar issues when
        structuring credit protection for the reinsurance recoverable of a
        respected Bermuda business. The issues and solutions are outlined in
        “Run off with the recoverables” which is also available from the
        website.


        BRAVE Partners services
        BRAVE Partners can assist both investors and issuers in identifying the best opportunities, underwriting
        teams and structures to assume insurance risks. Often these are not the standard structures of business
        lines, but if you stray off the fairway, then you need a good guide to keep you safe from the animals that
        lurk in the rough.




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