Frontiers of Risk Management

The Shareholder Wealth Effects of Insurance Securitization: The Case of Catastrophe Bonds

2010-12-10T05:23:00.000-08:00

By Bjoern Hagendorff, Jens Hagendorff, and Kevin Keasey

Abstract: Insurance securitization has long been hailed as an important tool to increase the underwriting capacity for companies exposed to catastrophe-related risks. However, global volumes of insurance securitization have remained low to date raising questions over its benefits. In this paper, we examine changes in the market value of firms which announce their engagement in insurance securitization by issuing catastrophe (Cat) bonds. Using a unique sample which consists of the near population of Cat bond issues by listed companies, we report some limited evidence that Cat bonds have positive performance effects as captured by wealth gains for shareholders in the issuing firm. More important, however, gains from Cat bonds appear to be linked to issuers optimizing the cost of catastrophe risk underwriting. Thus, abnormal returns are particularly large for issues by firms whose risk-profile will make it difficult to obtain competitively-priced reinsurance coverage as well as for issues during periods when prices for catastrophe coverage (including Cat bonds) are low.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1718303

Swiss Re places EUR 275 million of European windstorm risk on behalf of AXA (Swiss Re)

2010-11-03T04:36:00.000-07:00

Swiss Re Capital Markets has successfully structured and placed EUR 275 million of notes issued by Calypso Capital Ltd. (“Calypso”) covering European windstorm events. Calypso is a special-purpose company incorporated in Dublin, Ireland. The transaction sponsor is AXA Global P&C.

The notes, which provide protection on an occurrence basis, are the first to utilise a PERILS index trigger weighted by CRESTA zone (country-specific zones for uniform data reporting) and by line of business.

Calypso's single tranche series 2010-1 notes are the first issuance under a EUR 1.5bn principal-at-risk variable-rate note shelf programme. The three-year notes are rated “BB (sf)” by Standard & Poor’s and are scheduled for redemption in January 2014. Collateral for this issuance consists of a global master repurchase agreement with BNP Paribas.

Calypso was structured to provide AXA Global P&C with cover for European windstorms in Belgium, Denmark, France (excluding overseas territories), Germany, Ireland, Luxembourg, The Netherlands, Switzerland, and the U.K.

“We are pleased to support AXA's risk management objectives with a transaction that is the largest single European wind exposed ILS issuance to date. It marks further strategic leverage of the data supplied by PERILS,” said Jean-Louis Monnier, Swiss Re's Head of ILS Europe. “The ILS market continues to benefit from the enhanced transparency that PERILS brings to the European insurance sector."

Swiss Re Capital Markets acted as a structuring agent and joint bookrunner for the offering.

Independent third-party risk analysis for the notes was provided by EQECAT, Inc.

The Calypso notes were sold in a private placement pursuant to Rule 144A of the U.S. Securities Act of 1933, as amended, (the “Securities Act”) and have not been registered under the Securities Act or any state securities laws; they may not be offered or sold in the United States except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws.

Swiss Re says time is running out for effective longevity funding solutions

2010-08-31T05:22:00.000-07:00

Swiss Re today publishes its report “A short guide to longer lives: Longevity funding issues and potential solutions”:

The report warns that underestimating life expectancy by just one year can increase a pension plan's liabilities by up to 5%. It examines what (re)insurers and other parties can do to help address the challenges faced by societies as a result of increased life expectancy. The report also includes recommendations for the key parties involved in addressing longevity funding issues.

Over recent years, people’s life expectancy has risen substantially and this trend is likely to continue. Swiss Re’s report looks at what governments, pension plans, insurers and reinsurers can do to help address the challenges faced by societies as a result of increased life expectancy.

Christian Mumenthaler, Head of Life & Health Products and member of Swiss Re’s Group Management Board, says: "While life expectancy is on the increase, the time required for implementing effective longevity funding solutions is running out. Insurers, governments and pension providers must act now to ensure that living longer remains a benefit to society, rather than a financial burden."

Insurers and pension funds have an obligation to pay and reserve for accumulated pension benefits. Underestimating life expectancy by just one year –a relatively small miscalculation – can increase liabilities by up to 5%. So, for a pension plan with USD 1 billion of liabilities, an extra USD 50 million would need to be funded.
UK longevity market most developed
While the trend towards longer lives is global, some markets are impacted to a greater degree from a funding point of view. Though currently most developed in the UK, longevity insurance activity is expected to develop in a number of markets, including the Netherlands, the US and Switzerland – countries with material exposures and a high level of private pension provision.
Well-diversified (re)insurers are a natural home for longevity risk
A well-diversified (re) insurer will have a combination of mortality risk and longevity risk along with other non-correlated insurance perils, such as property and casualty. This type of diversification means insurers are often the ‘natural home’ for longevity risk. The recent development of insurance-based (or “indemnity”) solutions are an important factor in transferring longevity risk to these natural holders.

Recommendations for the parties involved:

Employers and pension plan trustees should assess whether they are reserving for longevity at an appropriate level and examine the feasibility of transferring some, or all, of the risk.
The insurance industry must encourage the development of more sophisticated risk models that recognise potential future longevity trends, especially in light of Solvency II and similar regulatory initiatives.
Governments and regulators need to consider re-aligning retirement ages with life expectancy and implement consistent regulation and accountancy guidelines. Additionally, governments should look to public-private partnerships to address their own longevity exposure through defined benefit schemes, which are backed by the state. Governments should also support the development of a longevity capital market through the publication of reliable, consistent mortality data to allow the production of transparent and robust indices. Annuity providers will need additional longevity capacity in the longer term and the capital markets may be able to provide some of this.

To find out more and download the report go to: www.swissre.com/longevity

Alternative Risk Transfer: Part II, Non-Life Utilization of Insurance-Linked Securitie

2010-08-13T04:56:00.000-07:00

By Christopher Kampa and Paul Siegert

Abstract: Part II of the Alternative Risk Transfer Series, "Non-Life Utilization of Insurance-Linked Securities, " provides an overview of the non-life insurance-linked securities sector, from the first securities issued - catastrophe bonds - to derivatives and synthetics. This paper charts the industry developments that have created a wide avenue of risk management techniques, allowing for the hedging of risks that were previously thought to be uninsurable.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1652889

Guy Carpenter Q2 2010 CAT Bond Update: Index to articles

2010-08-12T19:15:00.000-07:00

Catastrophe Bond Update: Second Quarter 2010 - Activity Surges…Reflecting Favorable Issuance Conditions and Strong Investor Demand: Part I: In the second quarter of 2010, eight catastrophe bond transactions were completed, and USD2.05 billion of risk capital was issued, making it the second most active second quarter on record. USD1.70 billion of this total (and all but one transaction) included exposure to U.S. wind as sponsors and investors focused on this peril, leading into what is expected to be an active North Atlantic hurricane season.

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Catastrophe Bond Update: Second Quarter 2010 - Activity Surges…Reflecting Favorable Issuance Conditions and Strong Investor Demand: Part II: Execution Study and Further Commentary on Second Quarter Market Dynamics: During the fourth quarter of 2009, the first quarter of 2010 and the beginning of the second quarter of 2010, transactions had generally been reaching issuance targets or upsizing and pricing at or below the midpoint of their initial spread guidance range. This trend moderated and in some cases reversed itself during the second quarter of 2010 as investors, though flush with cash due to inflows and maturities of existing positions, were disinclined to accept additional U.S. wind risk. Because nearly all of the new issuance available during the second quarter included U.S. wind exposure, transactions coming to market in late April or May faced more challenging market conditions which in some cases resulted in concessions being made by protection buyers with respect to deal size and spread levels.

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Catastrophe Bond Update: Second Quarter 2010 - Activity Surges…Reflecting Favorable Issuance Conditions and Strong Investor Demand: Part III: Second Quarter 2010 versus First Quarter 2010 and Second Quarter 2009: Second quarter of 2010 issuance activity increased relative to first quarter of 2010, both in terms of transaction count (eight versus six) and risk capital issued (USD2.05 billion versus USD808 million). Median transaction size was USD245.0 million in the second quarter of 2010 relative to USD125.0 million in the second quarter of 2009. Increased transaction size is due primarily to market conditions. In the first six months of 2009 spreads were at or near their all time widest levels due to lingering credit crisis concerns and expectations of an active 2009 North Atlantic hurricane season. Spread levels have tightened 20 to 30-percent year over year, due to increased systemic stability, net new inflows into catastrophe bond asset managers, maturities of outstanding bonds, and competitive pressure from the traditional reinsurance market that continues to tighten. At lower spread levels, sponsors that had reduced or even postponed their catastrophe bond transaction during the second quarter of 2009 elected to target increased transaction sizes during the second quarter of 2010.

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Alternative Risk Transfer: The Convergence of the Insurance and Capital Markets

2010-08-12T19:04:00.000-07:00

By Christopher Kampa and Paul Siegert, Insurance Studies Institute

Abstract: Part I, "A Broad Overview," details the evolution of Insurance-Linked Securities (ILS). Once considered to be an alternative form of risk transfer, ILS have become a mainstream method for transferring risk from insurers to the Capital markets. Parts II and II, to be released in late summer 2010, provide a micro-analysis of the non-life and life insurance-linked security sectors.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1646523

Hymans-Robertson Update on Pension Buy-outs, buy-ins and longevity hedging

2010-08-09T07:24:00.000-07:00

Welcome to our quarterly update, where we summarise the activity in the buy-out, buy-in and longevity hedging market during the second quarter of 2010, as well as a full overview of the past 12 months.

Buy-outs, Buy-ins and Longevity Hedging. Q2 2010 Update

CCFE Announces First Trades in Two IFEX Wind Contracts

2010-07-30T04:20:00.000-07:00

(CHICAGO – June 28, 2010) Chicago Climate Futures Exchange^® (CCFE^®), a Commodity Futures Trading Commission Designated Contract Market, today announced the first trades in the IFEX Northeast and Gulf Coast Tropical Wind contracts:

1,000 Northeast Tropical Wind (IFEX-NEW) contracts traded - June 25, 2010
1,000 Gulf Coast Tropical Wind (IFEX-GCW) contracts traded - June 18, 2010

The IFEX Event-Linked Futures contract is a financial instrument that offers market participants an opportunity to hedge against insured economic losses associated with wind damages in the United States. IFEX contracts, to a large degree, replicate the economics of an Industry Loss Warranty reinsurance policy in which a contract is made between the buyer and seller via IFEX and CCFE. In addition to the IFEX-NEW and IFEX-GCW contracts, CCFE also lists IFEX contracts based on U.S. Tropical Wind, Florida Tropical Wind and Eastern Seaboard Wind.

More information on IFEX products
Complete list of CCFE products
Complete price, volume and open interest information on CCFE products

About Chicago Climate Exchange and Chicago Climate Futures Exchange

Chicago Climate Exchange (CCX) is the world’s first and North America’s only legally binding, rules-based greenhouse gas emissions allowance trading system for all six greenhouse gases. CCX began trading in 2003 and today has more than 400 members who are leaders in greenhouse gas management and mitigation. Climate Exchange plc owns CCX, including the CCX-subsidiary Chicago Climate Futures Exchange (CCFE), as well as the European Climate Exchange (ECX). Climate Exchange plc is a publicly traded company listed on the AIM division of the London Stock Exchange (CLE.L). CCFE is a CFTC designated contract market which offers standardized and cleared futures and options contracts on a broad range of environmental products.

China plans weather insurance to help farmers

2010-07-20T07:35:00.000-07:00

The China Daily is reporting that "China may roll out its first weather insurance coverage before the end of the year to help farmers cope with economic losses from natural disasters."

"The policy will first be carried out on a pilot basis in Fujian province, an area that is frequently hit by typhoons," a source with a major insurer told China Daily on Monday.

A weather index insurance will pay out a contractually predetermined amount should the observed result meet the policy's requirement. It is different from traditional agriculture insurance, which requires adjustment for losses and claims auditing.

"Such a policy will largely reduce insurers' underwriting cost and boost their initiatives to underwrite more agriculture insurance - a usually loss-making business," said Hao Yansu, a professor of insurance policy at the Central University of Finance and Economics.

The country's current insurance coverage is unable to offer adequate compensation for losses from catastrophes, statistics from the China Insurance Regulatory Commission (CIRC) showed.

Insurers cover about 30 percent of losses from natural disasters in developed countries, but that figure is below 5 percent in China - a country that is frequently hit by a wide range of natural disasters.

As of last Friday, about 38.2 million people in 10 southern provinces and Chongqing municipality had been affected by continuous rainstorms and floods since July 1, the Ministry of Civil Affairs said in a statement on its website.

About 124,000 homes have been destroyed and more than 1.3 million people relocated, it said. Direct economic losses were estimated at about 29.5 billion yuan ($4.4 billion), up from Thursday's 26 billion yuan.

The weather insurance project was launched last September as an important part of an economic cooperation deal signed by China and Germany last year. The CIRC and the China Life Property & Casualty Insurance Company Limited promoted the project.

"Weather index insurance could play an important role in helping farmers mitigate their economic losses and rebuild their homes, especially when there is still no catastrophe insurance scheme in China," said an analyst with the country's major non-life insurer.

Global losses from natural disasters in 2010 could be three to five times what they were in 2009, said Thomas Hess, chief economist of the world's second-largest reinsurer, Swiss Re.

Economically advanced nations tend to purchase more insurance coverage, which helps to finance the costs of reconstruction. Less developed economies can also benefit from insurance coverage, especially if the public and private sectors - insurers, reinsurers, brokers, governments and international agencies - work together, Hess said.

Crop-insurance hope for Jamaica's agriculture

2010-07-20T07:32:00.000-07:00

According to the Jamaica Gleaner, "some relief is on the horizon for Jamaican and regional farmers who have been forced to endure the effects of extreme weather events without crop insurance."

The Caribbean Catastrophe Risk Insurance Facility (CCRIF) has signaled its intention to support the Caribbean Community's com-mitment to developing affordable agricultural insurance solutions.

While the facility is not specifically designed for agri-culture and will not benefit farmers directly, Executive Director Dr Simon Young noted that the CCRIF provides an opportunity for governments and their agents to access cost-effective re-insurance for the agricultural sector.
Risk-pooling facility
"It will be up to governments and the private sector to build institutions and systems which can aggregate the farmer's risk into a single portfolio, either at a sub-national, national or regional level, which CCRIF can then provide onward coverage against natural catastrophes," Young said.
Described as a "risk-pooling facility", the CCRIF offers parametric insurance to member governments against the impacts of hurricanes, tropical storms, and earthquakes and, come year-end, excess rainfall. Parametric insurance provides budgetary support payments to the affected countries, based on specified intensities of the event and not on actual losses.
The CCRIF remains the world's first and only multi-country parametric insurance fund. Its chairman, Milo Pearson, said recently that it was designed to limit the financial impact caused by the devastation of hurricanes and earthquakes by providing "short-term liquidity" when the policy is triggered.
Japanese funding
Launched in 2007, following Hurricane Ivan's devastation of the region in 2004, CCRIF was developed through funding from the Japanese government and capitalised through fees from its 16 member governments, the World Bank, the Caribbean Development Bank (CDB), the European Union, the governments of Canada, the United Kingdom, France, Ireland and Bermuda.
CCRIF's newest tool is regarded as being critical to the development of parametric solutions for the agricultural sector. The synthetic excess rainfall model will provide rainfall data that will enhance the management of excess rainfall and drought risks. The tools could support local efforts to find suitable insurance instruments for local industry.
Crop insurance is "essential to making the business (farming) a success", Director General of the Coffee Industry Board (CIB) Christopher Gentles noted, pointing to a World Bank-funded study now being under-taken by the CIB. The study is to establish wind and rainfall patterns in the Blue Mountains in an effort to establish risk, design a suitable product and establish a pilot programme for the industry. Productivity and profitability of coffee and banana, two of Jamaica's best export crops have, over the years, been severely impacted by severe weather events.
Crop insurance became less accessible after Dyoll Insurance crashed in 2004; following Hurricane Ivan's devastation of the region. After Hurricane Katrina in 2005, re-insurance options to the region dwindled because of its vulnerability to natural hazards. Crop insurance policies are now too expensive and are generally offered as non-catastrophic policies- providing no coverage against extreme weather events.
Among the CCRIF's member states are Jamaica, Anguilla, Antigua and Barbuda, Bahamas, Barbados, Belize, Bermuda, Cayman Islands, Dominica, Grenada, Haiti, Jamaica, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines, Trinidad and Tobago and the Turks and Caicos Islands.

Securitized Insurance Risk Strategic Opportunities for Managing Catastrophic Risk in Nigerian Insurance Market

2010-07-20T07:23:00.000-07:00

By Festus Epetimehin

Abstract: The recapitalization and consolidation of the Insurance Industry have brought into the capital market forces of change, to both sectors which are good for the development of the sectors. Such ventures suggest that insurers, reinsurers and intermediaries are all in stronger position to deal with a catastrophic event.(Swiss Re 2007)

Nigeria over the years is exposed to more man-made and technical disasters and some natural catastrophes. Apart from isolated cases of earth tremor, there has not been any major case of earthquake, volcano eruption, cyclone or hurricane. However, rainstorm and floods often cause havoc during the rainy season resulting to loss of lives, and extensive damage to properties, thus rendering thousands homeless.

The traditional markets still do not have the capacity to absorb these ever increasing catastrophe losses. Thus, insurance companies are actively seeking alternative forms of risk transfer that will help in taking care of the surplus in the event of more than one mega-catastrophe occurring in any one year, when some of the reinsurers themselves may become insolvent.

This paper provides an overview of what securitization of risks is all about, and the current development in the insurance industry. The usefulness of the instrument in developing the Nigeria insurance market. Finally, recommendations and conclusions were made on how the instrument could be adopted in the Nigerian Insurance market.

Download the paper here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1619712

RMS Unveils New Approach To Quantifying Longevity Risk

2010-07-14T04:59:00.000-07:00

Calif – July 12, 2010 – A ground-breaking medical-based approach to quantifying longevity risk that takes account of changing mortality phases was unveiled by Risk Management Solutions (RMS) today. The RMS® Longevity Risk Model examines expected future waves of mortality improvement that depend on changing social patterns, healthcare expenditure, and the development of new medical treatments, as well as historical phases of change. Exploring how transitions occur between the different phases provides companies with a better assessment of longevity risk than conventional models that use forward projections of past statistical trends.

“Most existing probabilistic longevity models measure current mortality trends, but fail to adequately capture the medium and long-term dynamics of mortality change,” commented Dr. Andrew Coburn, vice president of RMS’ Emerging Risk Solutions business unit. “Our model suggests that the level of mortality improvement we’ve seen in the last 30 years is likely to tail off in 15 to 25 years, which means the traditional methods that project forward current trends may be overestimating the longevity risk.”

Mortality improvement rates for U.K. adults across all ages have reached more than two percent a year, mainly driven by a decrease in the number of people smoking and the healthcare industry’s effectiveness in reducing premature deaths, particularly from heart disease. However, both of these trends have diminishing returns in improving mortality, as smoking rates have already dropped to low proportions and the decline in premature deaths related to cardiovascular disease treatments is slowing down.

“Mortality improvement is driven by multiple causes each playing out over different timeframes. Overestimating the extreme risk based on statistical extrapolations of recent variation may be leading insurers to hold too much capital that could be used elsewhere in the business,” said Dr. Coburn. He added: “The timeframe and magnitude of mortality improvement are restricted by what is medically possible and socially attainable, and it is by putting parameters around these uncertainties that we can draw a clearer picture of the risk.”

Future phases of mortality change
RMS has identified three major drivers of future mortality change, which are the subject of significant investment by leading biotech companies. These include the ‘Cancer Treatment Revolution’, the ‘Era of Regenerative Medicine’, based on breakthroughs in stem cell therapy, and the ‘Retardation of Aging’, driven by potential treatments to slow the process of cell degeneration.

“There are numerous potential scenarios that could play out in the future to change the profile of mortality risk,” said Peter Ulrich, senior vice president of Emerging Risk Solutions at RMS. “Our model allows insurers to gain a deeper understanding of their unique risks, which depend on the characteristics of their portfolios, rather than simply applying an industry average.”

According to the model, the most likely pattern for mortality improvement is that the current high rate will tail off in 15 to 25 years. This will be followed by a moderate and sustained improvement from Regenerative Medicine, peaking in the middle of this century, before a major wave of improvement occurs over the second half of the century from advances in our understanding of the biology of ageing.

The RMS® Longevity Risk Model draws on a robust scientific knowledge-base of medical studies, including an extensive catalogue of mortality and medical data, a database that tracks over 3,000 individual new drugs in development, population data, evidence of impact of historical epidemics, emerging patterns of infectious disease, as well as the mortality exposures in a number of pension portfolios. Initially focused on the U.K., the model will shortly be expanded for the U.S. and Continental European markets.

Longevity Genes Found; Predict Chances of Reaching 100

2010-07-02T04:54:00.000-07:00

According to a National Geographic report on a recent longevity study, "there's still no way to predict whether you'll live to be a hundred—but scientists are getting closer."

A newly discovered suite of 150 "long life" variants in about 70 genes allows scientists to guess, with 77 percent accuracy, whether a person can live into their late 90s or longer, a new study says.

(Get a genetics overview.)
These long-life gene variants, the authors speculate, may suppress genes associated with ailments often linked to aging, such as dementia and heart problems.

"This is just a genetic predisposition," cautioned study leader Paola Sebastiani, a biostatistician at the Boston University School of Public Health. "It doesn't mean that you're going to live to be a hundred. Many things can happen in life."

Naturally, lifestyle choices, environment, and plain good luck will always play major roles in determining life span—as they may have for the 23 percent of centenarian test subjects found to lack the telltale gene variants.

Maybe this minority "lived long simply because they had some tricks and avoided risk factors," Sebastiani said. "Perhaps they didn't smoke, didn't eat much red meat, or just lived healthier lives."

Billed as the world's largest scientific study of centenarians and their families, the New England Centenarians Study has collected data on more than a thousand Caucasian centenarians since 1995. Further studies will extend the research to other ethnicities, beginning in Japan, home to an inordinate number of centenarians.

In industrialized countries only about 1 in every 6,000 people will reach a hundred years of age. Just one in every seven million becomes a "supercentenarian," reaching 110. Eight-five percent of all centenarians are women.

(Pictures: "The Secrets of Longevity.")

From Centenarian Genes to Personal Fountains of Youth?

The new discovery, which the authors call a first step, may lead to people being able to learn in advance how long their bodies are predisposed to last.

Also, further studies of the 150 gene variants could yield advances toward personalized genomics and predictive medicine—particularly in regard to age-related ailments, the study team said.

The research has already revealed one surprise in this respect.

It's long been known that exceptional longevity runs in families, so many researchers have supposed that the long-lived might be lacking gene variants associated with age-related diseases.

But the new data show that centenarians have just as many of the disease-associated variants as other people. That means the longevity-related variants may somehow cancel or trump the variants associated with such ailments, according to the new study, to be published Friday in the journal Science.

However they do it, the centenarian gene variants generally appear to hold off disability and disease until the last years of lifes. Ninety percent of people who live to be a hundred remain disability free until about age 93, the researchers said.

(Also see "Yeast Life Extended Ten Times; Offers Hope for Humans.")

Longevity: More Than Just Genetics

Demographer Dan Buettner has spent years studying the world's longest-lived people and the places where they live, which he's dubbed blue zones. (Preview Buettner's article "The Secrets of Long Life.")

Buettner praised the new research and said it's long been known that people who reach a hundred not only live well but also have won the "genetic lottery."

"But genes and environment are inextricably interwoven," he said.

For example, environmental factors such as food, water, and air quality can shift rapidly, meaning the set of genes that helped today's centenarians live longer might not have the same benefit to babies born this year, said Buettner, a grantee of the National Geographic Society's Expeditions Council. (The Society owns National Geographic News.)

(Related: Buettner on the longevity lessons of a small Mediterranean island.)

Buettner believes genetic interventions could someday help slow the aging process—but that remains far in the future, he said. For now each of us must live with the genes we've been dealt, which means those hoping to live longer should look at their lifestyles.

"What we know now is that the average American could probably add about ten years of life expectancy and slow the biological clock," he said.

Eating better, and less, is a big part of the equation, he added. Other aspects are physical activity and mental focus—Buettner believes that people with a strong sense of purpose in their lives can live about seven years longer than those who don't have one.

"To take advantage of any possible future genetic interventions," Buettner said, "your best strategy right now is to optimize your lifestyle."

Allianz: "Cat bonds are a part of our risk management"

2010-05-27T10:23:00.000-07:00

The CEO of Allianz Re, Clemens von Weichs, explains why Allianz issues cat bonds as an alternative to traditional catastrophe reinsurance.

Allianz Re, the reinsurance division of Allianz SE, is responsible for structuring catastrophe bonds for the Allianz Group. What is a catastrophe bond and how does it work?

Clemens von Weichs: Catastrophe bonds, or cat bonds, transfer the risks of natural catastrophes to the capital markets. If an insurer has built up a portfolio of risk, then it might choose to pass part of this risk on to another party. This would reduce its own loss burden in case of a large event of this type, such as a hurricane or earthquake. It could purchase traditional catastrophe reinsurance to pass some risk on to reinsurers, which then would pay a part of the loss. Or it could sponsor a cat bond to pass the risk on to investors by way of securitization. If an event triggers the bond, the insurance company is entitled to use the capital of the bond for claims payments to policyholders. If the bond expires without a trigger event, investors will be paid back their capital plus a fixed coupon above a reference rate.

What is the economic rationale of the securitization of catastrophe risks for Allianz?

Allianz uses cat bonds as an alternative and a supplement to traditional catastrophe reinsurance. It's an alternative in terms of pricing and counterparty credit risk, and a supplement in terms of capacity sources.

Through its subsidiaries, Allianz accumulates significant amounts of risk in peak perils, in particular US hurricane, US earthquake and European windstorm, but potentially others too. At times when capital in the reinsurance sector is constrained, Allianz is keen to have access to all available sources of protection.

Further, the recent financial crisis has raised the awareness of counterparty credit risk which is also a relevant factor in reinsurance relationships. Allianz had begun to diversify counterparty risk by using non-traditional instruments of cat risk protection well before the financial crisis.

Do you plan further securitization transactions of insurance risks?

Allianz is dedicated to this market segment and has successfully issued five cat bonds during the past years. We intend to issue cat bonds from time to time to supplement traditional reinsurance cover. A precondition for that is that rates for risk protection are broadly in-line in both markets – the traditional reinsurance and the cat bond market. We continuously explore all possible options to fulfil our needs for risk protection as well as our expectations regarding pricing. Hence, cat bonds are a regular part of our risk management approach, and transactions like the Blue Fin Series 3 are planned in timing and structure according to our needs.

How do you perceive the market development?

Before 2007, the market for insurance-linked securities had developed to a stage where it began to expand into different types of risk. When the market picked up again in 2009, the majority of transactions focused on nat-cat risks in the US. The increased consideration of diversifying risks, such as European windstorm, could foster the growth of this market segment but this will also depend on converging price expectations of investors and sponsors.

EOS Wind Ltd. cat bond completes under target at $80m

2010-05-22T05:49:00.000-07:00

From the Guy Carpenter press release:

Guy Carpenter & Company, LLC, the leading global risk and reinsurance specialist, and GC Securities, today announced the completion of a USD80 million, two-class note issuance from a new 144A catastrophe bond vehicle, EOS Wind Limited, an Irish special purpose company incorporated with limited liability, to benefit Munich Re.

The EOS Wind Limited Class A Notes are exposed to U.S. hurricane events and utilize a state-weighted per occurrence PCS index trigger structure based on insured losses reported by PCS from a hurricane event. The Class B Notes are exposed to U.S. hurricane events and will use the same PCS index trigger as the Class A Notes, as well as European windstorm events which utilize a country-weighted Paradex trigger.

GC Securities was the sole bookrunner on the note issuance. The details of the catastrophe bond issuance are as follows:

Series 2010-1 Notes: Class A Notes
Size: $50m
Moody’s Rating: Ba3
Expected Maturity: May 26, 2014
Coupon: Treasury Money Market Fund Yield + 6.80%

Series 2010-1 Notes: Class B Notes
Size: $30m
Expected Maturity: Ba3
Moody’s Rating: May 26, 2014
Coupon: Treasury Money Market Fund Yield + 6.50%

QUOTES
Chi Hum, Global Head of Distribution, GC Securities
“GC Securities is pleased to have partnered with Munich Re, a seasoned sponsor of cat bonds, to access attractively priced capacity from capital markets investors. These investors have shown a willingness to support consistent issuers in the cat bond sector and very much appreciate the market presence of Munich Re.”

Henry Keeling, President & CEO – International Operations, Guy Carpenter & Company
“This cat bond transaction broadens the existing deep relationship that Guy Carpenter enjoys with Munich Re beyond the traditional markets to include accessing capital markets capacity. This is a great base from which to build productive partnering ventures in the future.”

Chartis completes $425m Lodestone Re Ltd. catastrophe bond

2010-05-22T05:47:00.000-07:00

From the Chartis press release:

Chartis today announced that it has entered into a reinsurance transaction with Lodestone Re, which will provide $425 million of protection to Chartis against U.S. hurricanes and earthquakes. This represents a substantial increase from the $250 million of protection originally sought by Chartis. To fund its obligations to Chartis, Lodestone Re issued a catastrophe bond in two tranches – $175 million of Class A notes and $250 million of Class B notes.

The transaction closed on May 12, 2010 and provides Chartis with fully collateralized coverage against losses from U.S. hurricanes and earthquakes on a per-occurrence basis until May 2013 using an index trigger with state-specific payment factors. Risk analysis for the transaction is based on Risk Management Solution’s (RMS) Hurricane Model Version 9.0 and RMS North America Earthquake Model Version 9.0.

Kristian P. Moor, President and Chief Executive Officer of Chartis, said, “As part of our first effort to obtain reinsurance coverage supported by capital market instruments, this transaction represents another important milestone in Chartis’ pursuit of increasing financial flexibility and enhancing our risk management capabilities.”

Lodestone Re is a special purpose insurer, incorporated under the laws of Bermuda, which has established a program structure enabling potential future catastrophe bond issuances.

S&P ILS Pre-Sale Reports Available On Line

2010-05-17T08:29:00.000-07:00

A complete catalogue of CAT bond pre-sales reports and ratings criteria are now available from S&P directly from their website: www.standardandpoors.com/ratings/ils/en/us

(Hat tip to Sarah Hills and the Thomson Reuters Insurance Linked Securities Community : https://inside.thomsonreuters.com/trading/ils)

AIG Buys $425 Million in Protection With Cat Bonds

2010-05-14T09:27:00.000-07:00

As reported on Bloomberg:

American International Group Inc.’s property insurer bought $425 million of protection from U.S. hurricanes and earthquakes through catastrophe bonds in the firm’s first purchase of reinsurance through capital markets. The securities involve two portions, one for $175 million and the second for $250 million, New York-based AIG’s Chartis unit said today in a statement. Both mature in 2013...

The purchases, through a special-purpose entity called Lodestone Re, reflect AIG’s “pursuit of increasing financial flexibility and enhancing our risk management,” Kristian Moor, chief executive officer of Chartis, said in the statement.
The $250 million slice will pay 8.25 percentage points more than three-month Treasury bills. The second yields 6.25 points above the benchmark. AIG divested its majority stake in reinsurer Transatlantic Holdings Inc. by selling shares in the past year.

And here's the Chartis press release:

Chartis today announced that it has entered into a reinsurance transaction with Lodestone Re, which will provide $425 million of protection to Chartis against U.S. hurricanes and earthquakes. This represents a substantial increase from the $250 million of protection originally sought by Chartis. To fund its obligations to Chartis, Lodestone Re issued a catastrophe bond in two tranches -- $175 million of Class A notes and $250 million of Class B notes.
The transaction closed on May 12, 2010 and provides Chartis with fully collateralized coverage against losses from U.S. hurricanes and earthquakes on a per-occurrence basis until May 2013 using an index trigger with state-specific payment factors. Risk analysis for the transaction is based on Risk Management Solution's (RMS) Hurricane Model Version 9.0 and RMS North America Earthquake Model Version 9.0.
Kristian P. Moor, President and Chief Executive Officer of Chartis, said "As part of our first effort to obtain reinsurance coverage supported by capital market instruments, this transaction represents another important milestone in Chartis' pursuit of increasing financial flexibility and enhancing our risk management capabilities."
Lodestone Re is a special purpose insurer, incorporated under the laws of Bermuda, which has established a program structure enabling potential future catastrophe bond issuances.

Florida Cat Fund Sells Bonds to Pay for 2005 Hurricane Season Claims

2010-05-13T08:54:00.000-07:00

From InsuranceNewsNet.com:

The Florida Hurricane Catastrophe Fund is about to sell $693 million in tax-exempt bonds to pay for losses the state-run reinsurer continues to experience because of claims from the 2005 hurricane season.
"Hopefully, this will give us enough resources to finish it all off," said Jack Nicholson, senior adviser of the fund.
The property insurance industry in Florida paid about $11.8 billion of claims from the very active 2005 season and the FHCF expects to pick up about $5.7 billion of that amount, said Nicholson. The year 2005 included hurricanes Dennis, Rita, Wilma and Katrina. Nicholson said an assessment levied on all homeowners, commercial and automobile insurance policies will be raised from 1% to 1.3% to back the bonds, so the FHCF could maintain a good credit rating.
Re-opened claims prompted the FHCF to ask for up to $710 million in bonds to reimburse insurers for claims from the hurricane season five years ago. Homeowners asking to re-open claims have been aided by public adjusters, who have quadrupled in number since 2004. Public adjusters, the industry has said, have looked to solicit business to profit from a law that allows a homeowner to file a claim five years after a storm. Part of a new law just passed but not yet signed by the governor would change that time limit from five years to three years to file a claim (BestWire, May 4, 2010).
The year 2004 actually had more total losses, Nicholson said, but there was less to fight over and the cases were settled. However, in 2005, there were more partial losses leading to more opportunity for public adjusters, and more re-opened claims.
The top five writers of homeowners multiperil in Florida in 2008, according to BestLink, were: State Farm Group, with a 17.7% market share; Citizens Property Insurance Corp., with 16.2%; Universal P&C Insurance Co., with 7.2%; USAA Group, with 5.1%; and Tower Hill Group, with 4.5%. BestLink provides online access to A.M. Best's Global Insurance & Banking Database.

Who Killed the WINEFEX?: Autopsy of the Bordeaux Wine Futures Contract

2010-05-13T04:54:00.000-07:00

By Eric Pichet, BEM-Bordeaux Management School

Abstract: Euronext’s September 2001 launch of the WINEFEX Bordeaux wine futures market quickly turned into a complete fiasco. The purpose of the present study is to analyse the reasons for this failure, the responsibilities of the various actors involved and the effects that this half-baked attempt to wed fine wine and market finance will have in the future. We will ultimately come up with three conclusions: the first will focus on what was an exceptional conjunction of technical errors and bad luck; the second clearly specifies Euronext’s responsibility in this affair; and the third discusses the pessimistic outlook for a viable wine futures market.

The original error clearly lies in the technical characteristics of the contract such as it was defined by Euronext. The small face value and the fixed conversion factor between the various grades of deliverable wine largely explains the lack of interest by the three actors who are indispensable to the success of a futures market: branch professionals; speculators; and arbitragers.

A second type of error relates to Euronext’s approach. At first, this exchange company misjudged the underlying asset’s volatility (and to be specific the exogenous elements that can cause variations in Bordeaux wine prices in general and in grand cru prices in particular). Even more surprisingly, Euronext executives then totally ignored objections coming out of Bordeaux regarding the WINEFEX’s feasibility.

Finally, the third type of error relates to the contract’s launch calendar. Although no one could have predicted the events of 11 September (nor their impact on a contract that had initially been planned for 14 September), the history of futures markets has long taught us that the best time to launch a contract is when a bull market is just at its outset. And yet, a long-term analysis of Bordeaux price cycles already indicated back in early 2001 that the underlying product was coming to the end of its upwards cycle.

The WINEFEX’s failure is likely to have two kinds of consequences for years to come: it will undermine the launch of any similar contract, mothballing all plans for wine futures, regardless of their particularities; and it also will force everyone to cogitate over the quasi-ontological general question of whether wines are basically soluble with market finance, and more specifically, whether a grand cru can be wed to a futures markets.

“A market is a success when it appeals to investors, speculators and arbitragists all at the same time”.

Download the paper here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1588753

Indian Weather Market Could See Dramatic Growth, Says Weather Risk Managment Association

2010-05-13T04:51:00.000-07:00

MIAMI, FLORIDA (May 12, 2010) – The Weather Risk Management Association (WRMA) released an industry survey of the Indian Weather Market today at its 12th Annual Meeting in Miami, Florida. The survey finds that the Indian weather risk management market could see major growth in several sectors with a total potential notional value of $2.35-billion (Rs. 105-billion) over the next two to three years.

The survey was conducted for WRMA by Weather Risk Management Services Ltd. India. The agricultural sector is a major contributor to the Indian GDP. With its high risk exposure to weather, agriculture has the biggest growth potential of all the sectors. Last year, the weather risk market for agriculture grew four-fold due to the huge growth in weather insurance linked to farmers with outstanding loans. The market rose from $22-million in 2008-2009 (Rs. 1-billion) to $100-million (Rs.4.5-billion) in 2009-2010. Subsidized weather insurance accounts for 95% of the market.

The survey estimates that Indian farmers and banks could become a notional $2.2-billion (Rs. 98-billion) market over the next two to three years. In five years, the weather risk market for agriculture is expected to rise to $7-billion (Rs. 314-billion) and could reach as $20-billion (Rs. 896-billion). Whether this growth materializes depends on government policies regarding weather derivatives. There’s great interest in weather risk management tools by the renewable energy sector to offset the impact of weather on wind, solar and hydropower. The renewable energy market’s use of weather risk tools is expected to grow to $1-billion (Rs. 44.8-billion) over the next five to seven years.

In the travel sector, airlines are often grounded due to winter fog.The survey forecasts that travel sector use of weather risk tools such as fog insurance could grow to $25-million (Rs. 1.1-billion) over the next five to seven years.

“The concept of using weather risk management tools is being accepted by more and more organizations around the world,” says Sandeep Ramachandran, WRMA board member and Director, Property and Specialty at Swiss Re. “WRMA’s Indian Weather Market Survey shows how these risk mitigation tools could benefit several important sectors of the Indian economy, especially the agricultural sector which is heavily dependent on the outcome of the monsoon season. Using weather risk management tools, the weather’s adverse impact on the these sectors can be mitigated.”

Longevity Risk Management for Life and Variable Annuities: Effectiveness of Static Hedging Using Longevity Bonds and Derivatives

2010-05-11T12:37:00.000-07:00

By Michael Sherris and Andrew Ngai

Abstract: For many years the longevity risk of individuals has been underestimated as survival probabilities improved across the developed world. The uncertainty and volatility of future longevity has posed significant risk issues for both individuals and product providers of annuities and pensions. This paper investigates the effectiveness of static hedging strategies for longevity risk management using longevity bonds and derivatives (q-forwards) for the retail products: life annuity, deferred life annuity, indexed life annuity and variable annuity with guaranteed lifetime benefits. Improved market and mortality models are developed for the underlying risks in annuities. The market model is a regime switching vector error correction model for GDP, inflation, interest rates and share prices. The mortality model is a discrete time logit model for mortality rates with age dependence. Models were estimated using Australian data. Basis risk between annuitant portfolios and population mortality was based on UK experience. Results show that static hedging using q-forwards or longevity bonds reduce longevity risk substantially for life annuities, but significantly less for deferred annuities. For inflation indexed annuities static hedging of longevity is less effective because of inflation risk. Variable annuities provide limited longevity protection compared to life annuities and indexed annuities, as a result longevity risk hedging adds little value for these products.

Download paper here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1587890

Aon Benfield CAT Bond Q1 Transaction Review

2010-04-28T04:28:00.000-07:00

Although catastrophe bond issuance for the first quarter was lower than prior years, the market continues to demonstrate strength. First quarters are traditionally slower than the second or fourth quarter in the ILS market, and are sometimes affected by “spillover” transactions which were attempted in a prior quarter but did not close. Q1 2010 did not include any spillover transactions from the prior quarter. In total, two transactions came to market during the first quarter for a total issuance of $300 million.

Download the report here: http://www.aon.com/attachments/reinsurance/201004_ab_ibg_ils_quarterly_1q_2010.pdf

Chart: Insurance Linked Securities Risk Capital Issued and Outstanding, 1997 – Apr 23, 2010*

2010-04-27T07:15:00.000-07:00

Original posted on GCCapital.com:

This chart represents the 144A Catastrophe Bond market. Capital outstanding peaked at approximately USD14 billion in 2007 and has remained fairly stable at approximately USD12 billion. It should be noted that other formats exist for investors, in addition to the 144A realm, such as the industry loss warranty market and collateralized reinsurance.

2010 Life Insurance Secondary Market – ‘Moving Forward’

2010-04-27T05:42:00.000-07:00

By Paul Siegert, Insurance Studies Institute

Abstract: “Caution” has been the carryover by-word from 2009 for good reason. Some would like to think the Life Insurance Secondary Market (“LISM”) has faltered. However, the LISM is indeed “moving forward!” This should be welcome news to seniors, investors and many LISM players, but unfortunately not for all. The capital markets turmoil has taken its toll and changes are happening.

2009 marked the LISM’s first year of contraction after experiencing over fifteen years of steady expansion. The LISM will again expand. We expect that with this next wave of expansion, the LISM will become more sophisticated and create valuable investment structures. We expect the LISM will continue to demand higher standards, fairer laws, consumer protections and consumer notifications. Investors will return. The life insurance secondary market is here to stay and will continue to provide a valuable option to seniors who do not want or need their life insurance policies.

Sophisticated investors are attracted to the life insurance asset class because they have access to resources to help them comprehend and understand the risks and the benefits. Consumers and policymakers often do not have access to such resources. For the LISM to truly materialize as a vibrant asset class, more education is needed for consumers, policymakers and industry stakeholders. If the LISM provides consumers and policymakers with the research and knowledge necessary to develop informed opinions, it will gain strength and value. More research and education is needed.

This paper attempts to summarize many of the dynamics occurring in the LISM as 2010 unfolds and to give perspective to some of the changes and challenges that need to be managed. In addition, ISI has visited with a strong sampling of executives from leading LISM firms to solicit their views on issues that are paramount in their minds.

Download paper here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1585439

Cass Business School Pension Institute

2010-04-17T20:01:00.000-07:00

Discussion paper collection: http://www.pensions-institute.org/papers.html

How longevity bonds may work

2010-04-14T19:23:00.000-07:00

Original posted on Reuters by Sarah Hills:

Pension insurers have been lobbying the British government to issue bonds linked to the longevity of the population, to help pension schemes and insurers manage the financial pressure of increased life expectancy.

Similar to the introduction of inflation-linked gilts first issued for pension funds in 1981, the government could issue a series of longevity-linked floating-rate bonds, creating a hedge against the financial risks posed by increase life expectancy.

Here's how the bonds would be structured:

* The bond pays coupons that reduce over time in line with the actual mortality experience of a particular age group in the population, such as 65-year-old males from the national population: so the coupons payable at age 75, for example, will depend on the proportion of 65-year-old males who survive to age 75.

* The bond pays coupons only and has no principal repayment.

* Coupon payments are triggered when the longevity risk is high: so, for example, the first coupon might not be paid until the cohort reaches age 75. The coupon payments continue until the maturity date of the bond which might, for example, be 40 years after the issue date, when the cohort of males reaches age 105.

* The final coupon incorporates a terminal payment equal to the discounted value of the sum of the post-105 survivor rates to account for those who survive beyond age 105. The terminal payment is calculated on the maturity date of the bond and will depend on the numbers of the cohort still alive at that time and projections of their remaining survivorship. It is intended to avoid the payment of trivial sums at very high ages.

* If population survivorship is higher at each age than was expected, the bond pays out higher coupons. This is what pension plans and annuity providers need to help match the higher than expected pensions and annuity payments they need to make.

* If, on the other hand, survivorship is lower at each age than was expected, the bond pays out lower coupons. But the pension plans and annuity providers are not likely to mind this, since their pensions and annuity payments are also likely to be lower.

Support for the idea:

* The Pensions Institute has cited a number of organizations that support the concept of governments issuing longevity bonds.

* The UK Pensions Commission and the IMF agree the government should consider their use to absorb tail risk for those over 90, while the OECD and the World Economic Forum argue that governments could improve the market for annuities by issuing longevity indexed bonds and producing a longevity index.

* The UK Confederation of British Industry said the government should drive development of a market in longevity bonds.

Who benefits?

* Proponents say the government gains by having both a more secure defined contribution (DC) pension savings market and a more efficient annuity market, resulting in less means-tested benefits and a higher tax take.

It earns a market-determined longevity risk premium, further reducing the expected cost of the long-term national debt.

* Defined Benefit (DB) schemes have the opportunity to reduce longevity risks and can hedge longevity risk exposure prior to buy out.

* Insurers can potentially establish a mark-to-market longevity risk term structure, and hence hold the optimal level of economic capital or at least hold capital closer to the economic level, in line with current proposals for Solvency II regulation, due to take effect in 2012.

* Capital markets would get help to kick-start market participation through the establishment of reliable longevity indices and key price points on the longevity risk term structure.

They can build on this longevity risk term structure with liquid longevity derivatives.

* Investors get access to a new (longevity-linked) asset class whose returns are uncorrelated with traditional asset classes, such as bonds, equities and real estate

* Pension plan members would have a means of hedging the longevity risk associated with purchasing an annuity at retirement.

Catastrophe Bond Update: First Quarter 2010

2010-04-13T08:20:00.000-07:00

Original posted on GCCapital.com:

In the first quarter of 2010, two catastrophe bond transactions were completed, and USD300 million of risk capital was issued (1). In response to strong investor demand, both transactions closed within initial price guidance and were upsized relative to announced placement targets. While this activity furthers the integration of the capital markets into the risk management processes of protection buyers, on balance, issuance volumes for the quarter were perhaps a bit lighter than expected at the close of 2009.

As the insurance linked securities (ILS) asset class continues to increase in prominence (and additional asset allocations are made to the space) issuance conditions continue to improve. For sponsors, this makes more compelling the argument for locking significant amounts of multi-year fixed price capacity. This is particularly relevant in the context of the catastrophe activity of the first quarter which included a significant earthquake in Chile and European winter storm Xynthia. The issuance outlook for the second quarter of 2010 is positive, with between 5 and 10 new transactions expected (covering a wide variety of perils) and more activity anticipated later in the year.

Issuance Activity
First quarter issuance activity kicked off in January with Foundation Re III Ltd., a USD180 million transaction sponsored by longtime catastrophe bond market participant, The Hartford. This transaction provides The Hartford with PCS (Property Claims Services)-index-based protection for hurricanes that may cause insured losses along the U.S. Gulf and east coasts, stretching from Texas to Maine. Foundation Re III Ltd., on which GC Securities served as co-manager, was upsized from the announced target of USD100 million and priced at the tight end of its initial guidance.

Swiss Re’s USD120 million Successor X Ltd. was the second transaction of the first quarter. This transaction provides Swiss Re with multi-peril protection with different trigger types and different risk profiles depending on tranche. The Series 2010-1 Class II-CN3 and Class II-CL3 Notes provide USD45 million and USD35 million of protection for the perils of U.S. hurricane and European windstorm. The Class II-BY3 Notes provide USD30 million of protection for the perils of U.S. hurricane, European windstorm, Japanese earthquake and California earthquake. Though one class of the Successor X Notes included at the transaction announcement was ultimately not placed, the transaction did price at initial guidance (for each tranche) and was upsized from an initial announced target size of USD75 million.

Notably, the Successor X Ltd. transaction was the first catastrophe bond to utilize a PERILS-based trigger for its European windstorm exposure. PERILS AG was launched in January 2009 and fills a role functionally similar for European windstorm losses (and eventually other European perils) that Insurance Services Office Property Claims Service provides for U.S. (and more recently Canadian) perils. The unbiased aggregation and extrapolation of actual losses and reserves to an industry-level figure provides comfort to protection buyers and can also be easily referenced in reinsurance and capital markets transactions.

First Quarter 2010 versus First Quarter 2009
First quarter of 2010 issuance activity declined relative to first quarter of 2009, both in terms of transaction count (two versus three) and risk capital issued (USD300 million versus USD575 million). It is important to note however, that first quarter activity is hardly an indicator of what to expect for the balance of the year as the peak issuance periods within a calendar year for the catastrophe bond market are historically the second and fourth quarters. Notably, the highest annual new catastrophe bond issuance on record (USD6.99 billion) occurred in 2007 with first quarter issuance equal to first quarter of 2010.

Risk Capital Outstanding
Over the first quarter of 2010 total risk capital outstanding declined USD588 million to USD11.92 billion as USD300 million of new issuance was outstripped by USD888 million of maturities. This is the first quarter of declining total risk capital outstanding since the second quarter of 2009. An additional USD4.08 billion of risk capital is scheduled to mature prior to year-end 2010. Risk capital outstanding peaked at the end of 2007, at USD14.02 billion. It then fell to USD12 billion by the end of 2008 before reaching USD11.3 billion at the end of July 2009. The current level is consistent with that of year-end 2008.

Issuance Composition
Of the USD300 million issued in the first quarter of 2010, USD180 million had exposure exclusively to U.S. hurricane peril; USD80 million had exposure to U.S. hurricane and European windstorm perils; USD40 million had exposure to U.S. hurricane, European windstorm, California earthquake and Japanese earthquake perils.

Industry Loss Warranties
Discussion and negotiation surrounding 2010 industry loss warranty (ILW) placements began late in the calendar year. Buyers were drawn on the one hand, toward ILW alternatives, with upper normal limit retrocession capacity readily obtainable and cat bond issuance vibrant, but attracted to falling ILW rates on the other hand.

The combination of overcapacity in the market, a benign 2009 U.S. hurricane season and model change prompted year on year pricing down by 20 percent for U.S. hurricane only protection and in excess of 30 percent for U.S. earthquake specific coverage. Markets were mindful of current conditions and offered reductions to secure renewal orders. Moreover, a number of opportunistic cedents bound protection with terms proving always more appealing.

However, particularly in the second half of the first quarter of 2010, ILW rates stabilized. Cedents’ appetites for absorbing catastrophe losses have shrunk following the recent earthquake in Chile so they have begun exploring additional cover for peak territories. As the U.S. hurricane season approaches, ILW market activity is likely to increase further.

In the first quarter of 2010, all 2009 participating markets with the exception of IPC Re returned to the ILW space. However, with prices softening for much of the first quarter it remained the rated carriers (rather than unrated hedge funds, which typically must collateralize their obligations) that provided the majority of ILW limits.

Outlook for Second Quarter and Remainder of 2010
The relatively light level of catastrophe bond issuance in the first quarter does not temper GC Securities’ bullish outlook for the balance of the calendar year. In our updates throughout 2009, we frequently mentioned the need for catastrophe bond spreads, in the aftermath of the credit crisis, to come back into rough approximation with the traditional market to spur further issuance. A great deal of progress has been made on this front, as spreads have come in better than 40 percent relative to the first half of 2009.

Looking forward, while the rate of spread tightening may moderate, net cash inflows to sector, and more than USD4 billion of scheduled maturities (the majority of which are expected to return cash into the hands of dedicated ILS funds) should continue to exert downward pressure on spread levels. Sponsors have certainly taken note of this price tightening, particularly in the context of what will likely prove to be the most costly first quarter (measured by insured losses) on record. Importantly, while the losses of the earthquake in Chile, European storm Xynthia and other catastrophe loss activity have created earnings strain for reinsurers globally, neither event has put catastrophe bond layers in meaningful jeopardy. Potentially, this could contribute to an environment where traditional rates stabilize or decline more slowly, further enhancing relative pricing and capacity available in the catastrophe bond market. Additionally, the attractiveness of fully collateralized, multi-year fixed price capacity tends to increase in an environment where significant catastrophe activity is at the forefront of protection buyers’ minds. The second quarter of 2010 should prove significantly more active than the first. While transaction activity is always difficult to predict, estimates of between 5 and 10 second quarter transactions are not unreasonable in our view, with total issuance for the year ranging from USD3 billion to USD5 billion.

Footnote:

[1] The risk period of State Farm’s USD350 million Merna Re II catastrophe bond, which was marketed during the first quarter of 2010, incepts on April 1, 2010 and therefore is considered a second quarter transaction.

Contributors:

• Chi Hum, Managing Director**
• Cory Anger, Managing Director**
• Hong Guo, Managing Director**
• Ryan Clarke, Vice President**
• Brad Livingston, Analyst**

ILW market commentary provided by:

• Barry Law, Managing Director (Guy Carpenter London)
• Larry Rothstein, Vice President (Guy Carpenter London)

Who wants to pay forever? Hedging longevity risk

2010-04-12T04:35:00.000-07:00

Posted on Reuters by Sarah Hills:

The ageing of Europe may open opportunities to sell savings products, but it also spells a real threat to parts of the financial services industry. Pensions experts call it the "toxic tail".

Like the subprime crisis faced by by banks in 2008, the risk of people living for up to 20 years after retirement seems to have crept up on an industry based on using historical data to calculate people's chances of an early death.

Now, pension funds and insurers say the mounting burden of protracted pensions payments is increasingly concentrated on a small group of providers: them.

Trying to spread this longevity risk to include capital markets and governments, they highlight concerns about corporate solvency and argue that fundamentally, provision for retired people who outlive expectations is a sovereign role.

"We don't want to see the equivalent of a banking crisis in the pension market," David Blake, professor of Pension Economics at Cass Business School, and director of the Pensions Institute told Reuters.

Nowhere better can the process be seen than in Britain, which is facing a crisis resulting from a combination of pension reforms and increased life expectancy.

As home to the world's second largest pension fund industry and one of the most sophisticated markets for private pensions, Britain's experience is worth exploring: other European countries are moving in a broadly similar direction, shifting the burden of old-age provision towards funded, private schemes.

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For a graphic showing 'tail risk' in UK longevity:

http://graphics.thomsonreuters.com/10/04/UK_FNC0410.gif

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Global pension private-sector liabilities are of the order of $25 trillion, according to OECD data in a January Pensions Institute report, which cited estimates that every additional year of life expectancy at age 65 adds around 3 percent to the present value of some UK pension liabilities.

Several factors -- the market crash brought on by subprime lending, new solvency rules for insurers due in 2012 and the stampede of baby-boomers to retirement age -- are adding urgency to providers' efforts to spread their exposure.

The UK has seen a flurry of over-the-counter longevity swaps deals, the biggest of which so far involved German car maker BMW in February offloading 3 billion pounds of risk from its UK pension scheme to Deutsche Bank's insurance subsidiary Abbey Life.

Abbey Life insured the longevity risk on the BMW pension scheme, taking responsibility for the payments and transferring a proportion of that risk to a panel of reinsurers.

Building on these deals, pension providers are working to construct capital markets instruments to slice and dice longevity risk into tradeable portions.

But the pensions industry says such markets should be underpinned by a roster of government bonds that are structured to help maintain payments to people who are tending to outlive even current expectations -- for example, those aged over 90.

If that seems like a small group, the evidence is it's the population segment most likely to grow. There are around 450,000 centenarians in the world today and experts estimate there could be a million across the world by 2030. For more details on how centenarians are the fastest growing demographic in the developed world, click here.

There's also mounting uncertainty about how many people will have died by age 90, and the Pensions Institute cites mortality projections which show some men at that age will live beyond 110 -- a long "tail risk" which may boost liabilities significantly.

"Longevity risk is a size that it should also go out to the capital markets," said John Fitzpatrick, a partner at Pension Corporation, which buys out liabilities and sponsors some pension funds. He is also a director of a fledgling venture to make such a market happen.

So far, neither capital markets nor the British government have been enthusiastic about the plan, although investment banks are behind the latest efforts to build a tradeable longevity swaps market.

Proponents of a longevity bond say they are receiving a more receptive response from the Conservatives, the party challenging Labour for government in elections due this spring, but the party declined comment.

WHO WILL BUY?

In a longevity swap like the BMW deal, the automaker reduced its exposure to its longer-lived pensioners by passing this liability to Abbey Life for 3 billion pounds ($4.6 billion). Typically, that premium is based on agreed mortality risks in the portfolio.

Abbey Life transferred a proportion of the risk to a consortium of reinsurers. The idea is that this risk is then passed onto investors such as Insurance-Linked Securities (ILS) investors, hedge funds and sovereign wealth funds.

They are attracted by the new asset class as an investment which would trade out of synch with traditional assets such as equities, bonds and real estate.

At the fundamental level, longevity risk is a good thing to own if you believe for any reason that more people will die sooner than currently forecast, if you have a portfolio that would lose money should such a catastrophe happen, or if you anticipate returns on the asset.

"Investors ... who own the risk of hurricanes, typhoons, earthquakes and lethal epidemics are ideally suited to take on longevity risk," said Fitzpatrick.

"There is no known correlation between the wind blowing and the earth shaking and how long UK pensioners live -- longevity offers a good diversifying risk for their portfolios," he said.

Capital markets players have already been involved in longevity transactions to a small degree: of the eight publicly announced swaps, the longevity risk was passed through to investors through reinsurers and investment banks.

But these have been bespoke deals. A key to developing such a market would be standardised indices. The Life and Longevity Markets Association (LLMA), of which Fitzpatrick is a director, was set up in February by a consortium of banks, insurers and pension experts to do just this.

HOT POTATO

Pricing the risk is complex. For a longevity transaction to happen, the investor, pension fund and investment bank have to agree on a forward projection of the cash flows related to either a population index or to a specific pension block.

And markets' resistance at current prices is palpable.

"Pension funds are marketing liabilities at unreasonable levels," said Andrea Cavalleri, head of Life at Securis Investments Partners, a fund dedicated to transferring insurance-linked risk to the capital markets.

"We often disagree with the mortality improvement assumptions provided by the pension funds in what can be outdated models," he said, underlining the basic problem -- people are living longer than previously expected.

"In reality, the capital markets should not be picking up the bill for unreasonable assumptions that the pension funds have on their books," he added, referring to liabilities the pension providers already hold.

Enter the government?

The many arguments in favour of a sovereign bond linked to longevity rest on one fundamental expectation: if pension providers can't pay, or become insolvent, governments will have to.

Longevity bonds could make the process neater, and more politically palatable, than the collapse of a pension provider.

"We will develop collateral mechanisms so investors can trade the risk themselves," said Fitzpatrick of the LLMA.

"But it would be helpful if the government did issue a longevity-linked bond, because such a system would reduce the amount of longevity risk that the government is likely to have in the future."

For a factbox on how a government bond would work, click here.

UNINTENDED CONSEQUENCES

A paradox in all this is that waves of pension reforms have been designed to shift the risk of providing for old age away from the state or corporates and onto the individual, and people have been encouraged to turn to capital markets to provide.

In principle, pension providers' liabilities have been reduced by moves away from the guarantees in Defined Benefit pension schemes towards less-secure Defined Contribution models, which are more like the U.S. 401(k) plans.

But in practice insurers say that even with the reforms, because people are living longer than expected, the risk of funding new schemes is becoming concentrated with them, especially in Britain.

"Insurance companies are beginning to play a big role in aggregating longevity risk in the economy," said the Pensions Institute paper, co-authored by Blake and Tom Boardman, director of retirement strategy and innovation at Prudential UK .

When they retire, Defined Contribution plan members usually use capital accumulated in the schemes to buy an annuity -- commonly sold by insurers -- to provide their future income.

So sellers of annuities are the ones now exposed to the risk that holders will typically live longer than expected in pricing the product. This "aggregate longevity risk" cannot be hedged, Boardman says.

"The situation is particularly acute for insurance companies operating in the European Union," said the paper. The insurance industry's equivalent of Basel II for banks, Solvency II, is due to be introduced in 2012 and currently proposes that insurers be required to hold significant extra capital to back their annuity liabilities if longevity risk cannot be hedged.

As a result, affordable annuities are becoming harder to find.

"If the private sector is unable to hedge aggregate longevity risk, it increases the likelihood that insurance companies stop selling annuities or increase annuity prices, which would reduce pensioner income in retirement," said Boardman.

LONGEVITY FLOATERS

The pensions industry wants the government to issue bonds whose coupon payments, made to pension plans and annuity providers, depend on survivorship: if more people survive at each age than was expected, the government pays higher coupons.

If, on the other hand, survivorship is lower than expected, the bond pays out lower coupons. Pension plans and annuity providers would see their payments also fall.

Boardman argues that the private sector can hedge risks at an individual level, but the government needs to provide the hedge against the trend. The industry says the bond could be similar to inflation-linked gilts first issued for pension funds in 1981.

"The government helped the development of the inflation swap market by issuing an index-linked bond because it gave a pure price for inflation risk to the market," said the Pension Corporation's Fitzpatrick.

"Likewise, it would be helpful for investors to be able to see a pure price for longevity. A large traded market in longevity would develop as you have today around inflation swaps."

The government has so far been averse to the implication that by issuing a longevity bond, it would be assuming the risk of the old getting older that no-one foresaw when pension reforms were implemented.

But the pensions industry points that the government is already exposed to longevity risk: private-sector pension liabilities and public sector funded pension plans both exceed 1 trillion pounds each, according to Boardman's paper.

"Nobody wants to take on the tail risk," said Blake. "The government bonds are necessary because the investors who have recently become interested in taking the other side of the longevity swaps market have no appetite for hedging long-duration tail longevity risk."

Securis Investments Partners' Cavalleri thinks it's simpler than that.

Unless the starting assumptions are appropriate, the need for pension and annuity players to hedge is misleading, he said.

"It is about getting rid of unwanted and unattractive risks. Frankly, we don't see who would want to be on the receiving side of that -- at least on current terms."

TAKE A LOOK - Ageing Europe

Europe is the world's fastest ageing major region. If it is to avert a future of decline and generational strife, the only thing the old continent can do is adapt.

The following is a selection of in-depth stories on the theme.

Main stories
- FEATURE-Pharma seeks genetic clues to healthy ageing
- SPECIAL REPORT-From the age of labour to the labour of age
- ANALYSIS-Pension funds mix it up to tackle longevity

Factboxes
- How longevity bonds may work - click here
- European pension funds budget for longevity - click here

The future of public debt: prospects and implications

2010-04-09T13:12:00.000-07:00

Original posted on Naked Capitalism:

In a new report, the Bank for International Settlements (BIS) – often called the “central banks’ central bank” – points out that bond investors are not as smart as they think, that Western debt is much higher than officially reported (since contingent liabilities and pension debts are excluded from official numbers), and that the recovery of the world economy may be crushed by fiscal problems.

The report states:

According to the OECD, total industrialised country public sector debt is now expected to exceed 100% of GDP in 2011 – something that has never happened before in peacetime. As bad as these fiscal problems may appear, relying solely on these official figures is almost certainly very misleading. Rapidly ageing populations present a number of countries with the prospect of enormous future costs that are not wholly recognised in current budget projections. The size of these future obligations is anybody’s guess. As far as we know, there is no definite and comprehensive account of the unfunded, contingent liabilities that governments currently have accumulated.

For background on the effect of aging populations on the economy, see this.

The report includes the following chart on age-related expenditures by country (click for clearer image):

Ambrose Evans-Pritchard succinctly summarizes BIS’ findings:

Official debt figures in the West are “very misleading” since they fail to take in account the contingent liabilities and pension debts that have mushroomed over recent years.

BIS writes:

More worryingly, the current expansionary fiscal policy has coincided with rising, and largely unfunded, age-related spending (pension and health care costs). Driven by the countries’ demographic profiles, the ratio of old-age population to working-age population is projected to rise sharply. Interestingly, this rise is concentrated in countries such as Japan, Spain, Italy and Greece, which are already laden with relatively high debts (Graph 2, left-hand panel). Added to the effects of population ageing is the problem posed by rising per capita health care costs.

In other words, BIS is slamming the Western nations for failing to budget for their rapidly aging populations and to set aside adequate funds during the boom. As Evans-Pritchard puts it:

BIS lamented the lack of any systematic data on the scale of unfunded IOUs that care-free politicians have handed out like confetti.

(And, of course, America has been spending money on both guns and butter).

Indeed, here are some recent stories about America’s pension crisis:

Barron’s ran a story on March 15th called “The $2 Trillion Hole: Promised pensions benefits for public-sector employees represent a massive overhang that threatens the financial future of many cities and states.”

Huffington Post ran a story April 5th entitled “‘Something’s Got To Give’: Massive Pension Fund Shortfalls Threaten To Bankrupt States”

World Net Daily ran a story the same day called “America’s future? U.S. cities going bust: Public employee pensions burdening states, localities “

The Los Angeles Times ran an op-ed on April 6th – written by the special advisor to Califonria Governor Arnold Schwarzenegger for jobs and economic growth – entitled “California’s $500-billion pension time bomb: The staggering amount of unfunded debt stands to crowd out funding for many popular programs. Reform will take something sadly lacking in the Legislature: political courage.”

The BIS report further points out that bond traders overestimate their timing and forecasting skills:

So far, at least, investors have continued to view government bonds as relatively safe. But bond traders are notoriously short-sighted, assuming they can get out before the storm hits: their time horizons are days or weeks, not years or decades. We take a longer and less benign view of current developments, arguing that the aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to boiling point. In the face of rapidly ageing populations, for many countries the path of pre-crisis future revenues was insufficient to finance promised expenditure.

Further, BIS notes:

Historical data shows that once public debts near 100pc of GDP they act as a ball and chain on wealth creation.

Actually, as Reinhart and Rogoff showed last December, 90 percent is the threshold:

The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies…

And, as Forbes noted about America:

Add the unfunded portion of entitlement programs and we’re at 840% of GDP.

And see this and this.

BIS concludes with this bearish scenario:

If countries do not retrench quickly, they will create a market fear of “monetization” that becomes self-fulfilling. “Monetary policy may ultimately become impotent to control inflation, regardless of the fighting credentials of the central bank” it said.

Some states may be tempted to carry out a creeping default by stoking inflation. “The payoff to do this rises the bigger the debt, the longer its average maturity, the bigger the fraction held by foreigners.” The BIS said the danger that any government would consciously take this path is “not insignificant” in the longer run.

Of course, a brutal fiscal purge in every major country at once itself poses a danger. The result would be to crush recovery and tip the world economy back into crisis, making deficits worse again.

Ultimately, though, the primary cause of this acute stage of the global debt crisis is very simple.

As BIS warned in 2008, nations worldwide were bailing out their private banks by transferring toxic risk from the banks onto the sovereigns’ own books. The giant banks are, of course, still drowning in debt and – using real world accounting – insolvent, due to all of their gambling schemes gone wrong and toxic assets. The “too big to fails” all over the world have acted like a drowning man who grabs onto someone else and – thrashing around wildly – ends up drowning both.

I don’t yet have an opinion on whether it’s a good idea or not, but debt repudiation appears to be a growing response to the debt crisis.

Insurance-Linked Securities Issuance Since 1997

2010-04-09T06:52:00.000-07:00

Original posted on Guy Carpenter's GCCapital:

On a standalone basis, the two most frequently securitized perils are U.S. hurricane USD(7.08 billion) and U.S. earthquake(USD 4.71 billion). Other perils securitized on a standalone basis include European windstorm, Japanese earthquake and, to a lesser extent, Japanese typhoon. Multi-peril transactions, in which the same dollar of risk principal is exposed to at least two or more perils accounts for 42 percent of total risk principal issued. Insurance linked securities (ILS) investors typically prefer single-peril / single-zone transactions as they provide greater ability to construct granular portfolios according to each investor’s risk preferences. ILS sponsors however, particularly large national and global writers with aggregate concerns across multiple perils and geographic zones, often prefer to economize risk transfer spend by applying a single limit across different non-correlated perils, for example U.S. hurricane and earthquake.

Insurance Linked Securities Issuance by Peril, 1997 - April 1, 2010

Source: GC Securities*

Have We Entered the Pension Twilight Zone?

2010-04-01T05:28:00.000-07:00

Original posted on the Pension Pulse:

On January 25, 2006, Phillip Bowring wrote this op-ed piece in the NYT on pension liabilities:

A remarkable if obscure event last week highlighted the potentially colossal impact on the global economy of the collision of two forces: the pension needs of aging populations throughout the developed world and the collapse of long-term interest rates. Pensions do not feature in the long list of subjects to be discussed at the World Economic Forum in Davos this week, but they ought to.
The event last week was the fall in the rate of return of 50-year inflation-indexed British government bonds to under 0.4 percent. That is far worse than anything even Japanese savers have experienced - the inflation adjusted on yen bonds was never below 1 percent.
The British bond bubble is exceptional and caused in part by regulations that force pension fund trustees to seek safety more than yield. But it is also part of a global phenomenon. For example, yields on 20-year U.S. Treasury inflation-protected bonds are 1.9 percent and those on French, Canadian and other equivalents are lower. Conventional bond yields are close to record lows almost everywhere, including emerging and higher risk markets such as Russia and Argentina.
So why should this be a problem? Are not low interest rates good for economies, stimulating consumption and encouraging investment? Unfortunately, not always - particularly when pension schemes in many companies and countries are already inadequate to meet future obligations.
In the case of Britain, the fall in long-term rates over the past year has added $30 billion to the existing pension fund deficits. In the United States, many funds already had overly optimistic of rates of return on funds. For the time being, a pick-up in some equity markets may be delaying a day of reckoning. But funds assuming an annual return of 8 percent to 9 percent, when 10-year treasuries yield half that and corporate dividend yields are under 2 percent, will face a crisis if yields do not rise.
Low long-term interest rates are having or will have very serious negative consequences that outweigh temporary apparent benefits:
The more aware corporations become of the further growth in their unfunded pension liabilities, the less willing will they be to invest surplus cash in new ventures. It will go to shore up the funds. In the United States, the weak corporate investment response to very healthy profits suggests this is happening already.
As in Japan, low interest rates have minimal impact on willingness to consume. Instead they make it seemingly painless for the government to borrow heavily for investment in schemes and bridges to nowhere.
Low long-term interest rates encourage asset bubbles of all sorts. The world may not be in an equity bubble but many parts of it have been enjoying property bubbles - and now the bond bubble. That gives central banks, fearful of bubbles bursting, reason to delay return to more normal rates.
Low rates of return from bond and equity markets encourage a shift into nonconventional assets such as hedge funds and private equity. These promise higher returns but their lack of transparency and high leverage promise more train wrecks ahead.
Annuity yields are so low that pensioners will be forced to rely on the state for welfare.
It has become fashionable in the West to see "excess Asian savings" as the main cause of low bond yields. Yes, there is scope for China, South Korea, Japan and parts of Southeast Asia to spend more and save less. There is a trend in that direction already - and, in time, oil exporters now accumulating vast surpluses will also spend more of their new wealth.
None of this can adequately explain, however, why real interest rates in the United States can be at record lows while household saving is nonexistent and the government deficit enormous.Or why British rates are so low despite record levels of household debt and a rising government deficit.
A more plausible explanation is the extraordinarily rapid pace of money supply growth almost everywhere - in Europe, Australia and even Japan as well as in the lead money printer, the United States. Rapid expansion of reserve currencies has quickly been followed by monetary surges in Asia and Latin America.
Of course there are other influences. In the information technology era, growth may be less capital-intensive than during the era of steel. And global demographic change is adding to savings and reducing growth in demand for new houses and factories.
But the major central bankers and finance ministers should stop either blaming the Asiansor just musing over the causes of low rates. Individually and severally, they are supposed to be in control of money creation, credit growth and the supply of long-term public debt.
The problems of aging and pensions were already challenging enough. Current attempts to buy short-term expansion with artificially low interest rates can only make the long-term problems greater than ever.

Keep in mind that was written back in 2006, before the financial crisis hit. What has happened since then? Unfortunately, not much has changed:

There are fewer hedge funds but they control more assets. The same goes for the big banks where assets are concentrated in the hands of a few.
On Tuesday, Dominique Strauss-Kahn, the managing director of the International Monetary Fund said international drive to impose new regulations in the wake of the financial crisis is fading and global cooperation is diminishing.
Wall Street's bonus bonanza continues. The FT reports that top 400 executives of Credit Suisse will share a jackpot of more than SFr3bn when a special bonus scheme that reached maturity on Wednesday pays out next month.
Judging from the meeting organized by the Institutional Limited Partners Association Tuesday, March 30, in New York, the LPs want to elevate the dialogue -- to the industry level. But it is just a dialogue. Partly because there is less capital to go around for new funds against the backdrop of a vastly different environment, the give and take between GPs and LPs has become much more complex.
Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said the Fed is right to pledge to keep rates at record lows for an "extended period." But he — as Federal Reserve Chairman Ben Bernanke did last week — said that doesn't mean a specific time period or number of meetings.
Investors should acclimate themselves to years of lower-than-normal returns in both stocks and bonds, Pimco's Bill Gross told CNBC.

On the last two points, the Economist had an interesting discussion on the Dangerous curve:

What is going on in government-bond markets? Longer-dated bond yields have risen in recent weeks and the gap between long- and short-term rates (known as the “yield curve”) is much higher than normal. Potential explanations range from the benign (the economy is returning to normal) to the apocalyptic (investors have lost their appetite for government debt).

An upward-sloping yield curve, in which long-term interest rates are above short-term rates, is normal. You would expect creditors to demand a higher return for tying up their money for extended periods. An “inverted” curve, with short rates above long ones, is usually seen as a herald of recession, as it turned out to be before the credit crunch.

So what does a very steep yield curve tell us? One possibility is that the economy is heading for a vigorous recovery. For one thing, long rates are a forecast of future short rates. So the markets are essentially predicting that the Federal Reserve will eventually increase rates because the economy has been restored to health. In addition a steep yield curve creates profitable opportunities for banks, which can borrow short-term at a low rate and lend to companies at a higher one. The Fed engineered a steep yield curve in the early 1990s to boost bank profits after the savings-and-loan crisis.

This time, however, a steep yield curve is hardly stimulating bank lending. Bank credit has contracted over the past 12 months. Big companies are turning away from the banks to the bond market as a result: high-yield bond issuance in March broke the previous monthly record. Smaller companies have found it more difficult to borrow money.

A rise in long-term bond yields could indicate a belief that inflation is set to soar. But inflation expectations, derived from the gap between yields on index-linked and conventional bonds, hardly suggest fears of a Zimbabwe-style debasement. American inflation is expected to average just 2.4% between now and 2028.

There are other possibilities. One current technical oddity in the markets is the “negative swap spread”. In the interest-rate swap market borrowers exchange fixed-rate streams of payments for floating ones (or vice versa). The floating rate is often based on LIBOR, the rate at which banks borrow from one another. The fixed-rate element normally carries a higher yield than that of Treasury bonds with the same maturity. After all, the other counterparty in the swap will usually be a bank, which is less creditworthy than the American government. But on March 30th the fixed-rate element of a ten-year swap was paying 3.82%, while the equivalent Treasury bond was yielding 3.87%. Does that really mean the market considers banks a better credit risk than the Treasury? Given the continued use by banks of government-support schemes of various kinds, that seems ridiculous.

A more likely explanation is the sheer volume of bonds being issued. These bond issuers would rather swap their fixed-rate obligations for floating-rate ones. So they have to pay a floating rate and receive a fixed one. The result is an imbalance of supply and demand: those people willing to pay the fixed-rate part of the swap can get away with a lower yield than the American government.

In Britain a similar technical oddity has led to the 30-year swap spread being negative for a considerable period already. Demand from British pension funds, which use the swap market to hedge their long-term liabilities, has forced down fixed-swap rates. What is seen as an unusual situation in the American market may become the norm.

Technicalities aside, the most plausible explanation for the steep yield curve is the interaction of monetary and fiscal policy. On the monetary side the Fed is holding short rates at historically low levels in response to the severity of the crisis. On the fiscal side America’s budget deficit has soared to over 10% of GDP, leading to heavy debt issuance. Recent Treasury-bond auctions have seen fairly weak demand, forcing yields higher.

This still represents a challenge for markets. One reason why equities have rallied is that their potential returns have seemed attractive relative to government-bond yields. Now there will be more competition. And governments have been able to support their economies so generously because their financing costs have been so low. Higher yields will add to the pressure on them to tighten fiscal policy. A market and an economy too dependent on government support will have to learn to live without its crutch.

Add to this the problems of aging and pensions that are only going to add to fiscal woes, and you can see why bond yields will likely rise further as heavy debt issuance to cover these benefits places more upward pressure on yields.

Finally, there is a real risk is that tightening fiscal policy at a time when private demand remains weak could send economies back into recession. Welcome to the twilight zone.

Swiss Re sale marks milestone for ‘cat’ bonds

2010-04-01T05:25:00.000-07:00

Original posted in the Financial Times by Paul J Davies:

Swiss Re has sold the first catastrophe bond to use a recently created index of insurance losses from European storms, which is designed to make such deals easier to track and hence more attractive to investors.

The Switzerland-based reinsurer’s $120m deal, which comes as the insurance industry is forecasting losses of $2bn-$4bn from the recent winter storm Xynthia in Europe, also covers US hurricanes and US and Japanese earthquakes.

Cat bonds are used by reinsurers to help them cope with the most extreme losses from natural catastrophes and are bought mainly by specialised investors in insurance-linked securities and some hedge funds.

Swiss Re’s deal is only the second to be issued this year so far following a burst of activity towards the end of last year, which saw market volumes reach $3.5bn.

The market is expected to see volumes of up to $5bn this year, according to brokers at Aon Benfield.

Martin Bisping, head of non-life risk transformation at Swiss Re, said current market conditions should foster further issuance and that the new European storm index – called Perils – should help stimulate that activity.

“Perils is a major development,” he said. “It closes the gap [with the US market] to have an industry loss index provided by an independent company.”

Industry loss indices such as PCS, which have existed in the US for many years, provide estimates of broad insurance losses from individual events, such as hurricanes, soon after the events take place.

Investors like cat bonds based on indices or other so-called parametric measures because they offer quick certainty over whether their investment will face losses after an event.

Mr Bisping said neither Xynthia nor the previous year’s Lothar would have been of a great enough magnitude to trigger losses on Swiss Re’s cat bond.

However, the deal is quite risky for investors because it can be triggered by any one of four big event types over the three-year life of the deal.

Swiss Re Places Cat Bond Program Using PERILS Index

2010-03-30T09:41:00.000-07:00

Original posted in National Underwriter by Carolyne McDonald:

Swiss Re said it has arranged for an additional $120 million in catastrophe bond protection using windstorm loss estimates from the new PERILS European data aggregator.

Coverage, the firm said, is for North Atlantic hurricane, European windstorm, California earthquake and Japan earthquake losses and is the first cat bond transaction issued using a windstorm index based on PERILS industry data.

The reinsurer said it has entered into a transaction with Successor X Ltd. to receive up to $120 million of payments in the event of natural catastrophes.

Under the transaction a three-year covered risk period ends March 2013. Successor X, in turn, has issued notes linked to this risk to the capital markets. Successor X is a special purpose vehicle with a flexible program structure, which will allow subsequent issuances of notes.

Swiss Re noted it has a strong track record of securitizing its natural catastrophe risks, obtaining more than $1.6 billion of protection through prior Successor programs. The current Successor X program, with the first bond issued in December, securitizes an additional $270 million for the company.

Brian Gray, Swiss Re’s chief underwriting officer, explained this is the first cat bond transaction issued using a European windstorm index based on industry loss estimates from PERILS, which was formed last year.

PERILS is an insurance industry initiative aimed at improving the availability of catastrophe insurance market data. According to its Web site, PERILS' industry data are based on information exclusively received from insurers writing business in the territories covered by PERILS.

PERILS founding shareholders include: Allianz, AXA, Groupama, Guy Carpenter, Munich Re, PartnerRe, Swiss Re and Zurich. Each company holds equal equity in PERILS.

“Swiss Re welcomes this independent industry initiative and sees it as an important step toward more efficient and transparent risk transfer in Europe,” Mr. Gray said. “We have supported PERILS from the very beginning, and this demonstrates our continued commitment to driving innovation in the ILS [insurance-linked securities] sector.”

The triggers for the other perils covered by the new bond are based on parametric indices or modeled losses, said Swiss Re.

Successor’s offering consists of three series of notes of $35 million, $40 million and $45 million each. One class of the notes is rated “B-minus” by Standard & Poor’s, while the other classes are not rated. The collateral for this issuance of Successor X notes consists of Treasury money market funds, Swiss Re said.

Swiss Re Capital Markets acted as sole manager and bookrunner on the note issuance. Risk modeling and analysis were performed by EQECAT Inc.

Martin Bisping, head of Non-Life Risk Transformation, said that “Swiss Re employs the same rigid structuring processes and deep level of natural catastrophe expertise to minimize basis risk and create innovative risk transformation solutions for ourselves as we do for our clients. Managing complexity, basis risk and tail risk is part of our competitive advantage.”

The Successor X notes were sold in a private placement.

Swiss Re sale marks milestone for ‘cat’ bonds

2010-03-30T09:39:00.000-07:00

Orginal posted in the Financial Times by Paul J Davies:

Swiss Re’s deal is only the second to be issued this year so far following a burst of activity towards the end of last year, which saw market volumes reach $3.5bn.

The market is expected to see volumes of up to $5bn this year, according to brokers at Aon Benfield.

“Perils is a major development,” he said. “It closes the gap [with the US market] to have an industry loss index provided by an independent company.”

Investors like cat bonds based on indices or other so-called parametric measures because they offer quick certainty over whether their investment will face losses after an event.

Mr Bisping said neither Xynthia nor the previous year’s Lothar would have been of a great enough magnitude to trigger losses on Swiss Re’s cat bond.

However, the deal is quite risky for investors because it can be triggered by any one of four big event types over the three-year life of the deal.

Bermuda accelerates ILS drive

2010-03-29T05:46:00.000-07:00

Original posted on Reuters by Sarah Hills:

The Bermuda government and reinsurance industry want to position itself as the jurisdiction of choice for capital market investors wishing to create high level insurance securities against natural catastrophes.

Bermuda wants to increase its involvement in Insurance-Linked Securities (ILS) and has adapted its regulatory framework to allow the creation of a new class of insurer within the Bermuda insurance class system that structures single transactions, such as catastrophe bonds.

These Special Purpose Insurers (SPIs) are a reinsurance company that assumes reinsurance risks for a specific, single transaction - usually in the form of a cat bond. These securitisations will then be listed on the Bermuda Stock Exchange (BSX).

Insurers and reinsurers use catastrophe bonds to transfer to capital market investor's major risks on their books, such as for storms and earthquakes.

"There is a need for Bermuda to drive the convergence of capital markets with the insurance industry," Greg Wojciechowski, CEO of the BSX, told Reuters at the Bermuda business conference in London on Thursday, adding this is in response to the growing popularity of ILS transactions.

"Capital market participants are not investing in an insurance company, they are investing in a product created for transferring a risk into a security that has little or no correlation to events that happen in the broader financial sector," he said.

The BSX, which has over 650 listed securities and a combined market capitalisation of around $200 billion, has already listed seven cat bonds with a combined value of $370 million.

The most recent was Flagstone Re's $175 million catastrophe bond, Montana Re. The bond covers against U.S. hurricane and earthquake and was issued in December 2009.

The BSX will provide a listing that helps establish a level of transparency for the market, following the collapse of Lehman Brothers - which played a counterparty role in several cat bonds and highlighted the potential weaknesses of collateral structures.

"The first step is to put in place a mechanism through the BSX to support this convergence, and then we can create a 'publication' of secondary market activity to establish a regulated independent third party verification source for these bonds to be reported," Wojciechowski said.

ILS deals are private transactions with institutional investors and fall under rule 144a, which has hindered transparency of the structuring and trading of such transactions in the past.

"My aspiration is to create a central repository that is focused on the pricing points for these bonds. Bermuda senses that the next wave of capital creation in the reinsurance market will be through the creation of these SPI securitisations compared with the traditional incorporated companies," Wojciechowski said.

Bermuda's insurance market comprises almost 1,400 companies with total assets of $442 billion and gross premiums of $142 billion.

Longevity market has potential for rapid growth

2010-03-15T05:42:00.001-07:00

Original posted on Reuters by Sarah Hills:

The market for longevity hedging will develop rapidly, despite the complexities of offloading the risk that pension fund members live longer than expected, an industry report said.

Compared with buying annuities, longevity swaps allow trustees more control of their assets, giving the potential for higher returns and freeing up risk budget to employ in other areas, Steven Dicker, senior consultant at Towers Watson, said in a study by ClearPath Analytics released on Wednesday.

"Their use will develop rapidly, just as interest rate and inflation hedges have," he said, but warned that other risks still have to be managed too, and if incorrectly structured, the outcome could be ineffective or restrictive.

Pension schemes and sponsors should recognise that longevity hedging can be complicated and time consuming to set up and maintain, the report said.

It said some pension executives questioned whether the longevity hedging market had enough capacity and transparency to assist in the majority of pension plans, but others expected rapid growth in the sector.

James Mullins, senior liability management specialist at Hymans Robertson, predicted longevity swaps cover would exceed 10 billion pounds during 2010.

"Longevity swap deals will be most common for larger pension schemes who believe that the best way for them to de-risk is to carry out a "DIY-buy in"; that is to use interest, inflation and longevity swaps directly to reduce risk," he said.

But Jerry Gandhi, group pensions director at RSA Insurance Pension Fund, questioned whether there was the capacity for pension funds to hedge against ageing populations and its impact on pension liabilities.

"I sense at the moment the appetite for taking out risk through these sorts of structures for deferred members is less easy. Life expectancy is probably longer, time horizons are definitely longer and I'm not sure yet if there is an appetite for it," he said.

The recent 3 billion pound longevity transaction between BMW and Deutsche Bank in February marked the biggest deal of its kind, following the Babcock International, Royal County of Berkshire Pension Fund and RSA pension scheme deals last year.

In February, the Life and Longevity Markets Association (LLMA) was formed to transfer longevity risk to capital markets.

The LLMA, made up of a consortium of banks, insurers and pension experts, will develop a series of standardised indices that can be used as a global benchmark for trading longevity and mortality risk.

Most recently, UK construction firm Aggregate Industries Limited announced on Tuesday it had transferred 300 million pounds of pension risk to Pension Insurance Corporation as it looked to reduce risks in its two major pension schemes.

To see the report, see
http://clearpathanalysis.com/downloadreport.php?filename=report1.

Low volumes in exchange derivatives cloud true market interest

2010-03-15T05:40:00.000-07:00

Original posted on Reuters by Sarah Hills:

A shortage of risk protection buyers may be responsible for low trading volumes in exchange-traded catastrophe products, but does not represent the interest from investors looking to gain exposure to insurance risk, according to market traders.

Currently, volume on the exchanges appears low. Eurex is still waiting for its first hurricane future trade after extending its product offering to catastrophe derivatives in June last year.

In addition, the CME Hurricane Index (CHI), which is brokered by Tradition Re, has traded a total volume of just $112 million since February 2008.

Also, activity on IFEX, which offers Event-Linked Futures (ELFs) via the Chicago Climate Futures Exchange has appeared low. IFEX traded $200 million in volume since its inception in 2007, and traded only $1.2 million for the 2010 season so far. However, there has been over $100 million recently in bids and offers on screen, said the exchange.

For full details on ETP products and how to trade them, see http://communities.thomsonreuters.com/ILSExchangePrices.

"Insurance risk represents one of the most successful ways to diversify an investor's asset base," Billy Welch, a business development manager at IFEX told Reuters.

"We have seen an increased interest in Florida hurricane contracts as well a U.S wind products. In addition there has been significant interest in the U.S Gulf coast contracts, which cover Texas to Alabama from both buyers and sellers of protection."

Tradition Re, the fully licensed reinsurance intermediary who mainly brokers traditional reinsurance, but has started to broker Exchange Traded Products (ETP), recently completed a Dutch auction on behalf of a reinsurance market participant wishing to hedge their risk for the 2010 hurricane season in Florida. The deal cleared a total amount on the CME Hurricane Index of 400 lots equalling $4 million at a price of 11.43.

This follows another CHI trade for a second event binary Texas-Florida contract with a CHI strike of seven for 1,000 lots equalling $10 million at a price of 24.42.

"There has been a considerable amount of bids and offers in the market that have not been matched," said Matt Carter,vice president at Tradition Re. "There is in excess of $1.5 billion of capacity that has not been placed for buyer or sellers which tells us there is a growing acceptance of the products and depth in the exchange traded market.

"ETP have low transaction fees and are supported by very strong security. Buyers currently do not purchase the same volume on the exchange as they would for a cat bonds, but there is no reason why that cannot be accommodated," he said.

"The exchange traded cat products, whilst still in their infancy, are another useful tool available to insurance and reinsurance buyers and risk mangers. Like catastrophe bonds, swaps and ILW's they do bring benefits and have a valid place in the tower of protection purchased by most insurance and reinsurance companies," Patrick Gonnelli, executive vice president at Tradition Re told Reuters.

While at a macro level, proactive reinsurers and dedicated ILS funds and managers have increasingly been looking to support the new platforms and generate trading profits, there has been less demand for protection on the basis of buyers seeing sufficient capacity available in the traditional reinsurance market, according to John DeCaro, founding principal at Elementum Advisors.

"Reinsurance companies that want to buy non-indemnity protection are currently looking at Industry Loss Warranty's (ILW). There is also plentiful capacity in the ILW market and as well designed as an ETP may look, it represents a significant change in the buying habits of a protection buyer," he said.

It can be difficult to generate trading activity because there is not enough volatility in the market to move ETP prices up or down, said DeCaro. "In the absence of a natural catastrophe, there is generally nothing other than marginal increases in demand or supply of capital that causes prices to move," he said.

This could be one of the reasons that Eurex has seen low activity in the Over-The Counter (OTC) market and the comparable listed instruments market.

"Interest mostly depends on the expectations of the participants about this year's hurricane season. This might lead to an increasing appetite in hurricane derivatives," said a Eurex spokesperson, adding they had observed a tendency to prefer selling protection than looking to buy.

"Exchange-traded contracts are a very efficient and secure way of covering (or underwriting) catastrophe risk. The overall counterparty risk will attract more interest to exchange-traded and centrally cleared hurricane derivatives," he said.

An extreme hurricane season would spur an increase in trading in the market.

Five hurricanes, two or three of them major, are expected to strike the U.S. coast in what could be an above-average 2010 Atlantic hurricane season, private forecaster AccuWeather.com said on Wednesday.

The firm predicts a much more active 2010 season with above-normal threats on the U.S. coastline.

"There is trading activity that occurs over the course of a hurricane season. Advantages of an ETP are that a market participant is able to close out a position prior to the end of the risk period, and actively trade during a hurricane," said DeCaro.

Exchange-traded derivatives have a shorter development period, which means collateral can be released quickly - generally more so than through a collateralised ILW, DeCaro said.

IFEX has seen a great deal of success in signing up new clients to access to the market, said Welch. "ETPs are an efficient way to access the reinsurance markets and I see a trend moving towards using the exchanges because of the security benefits offered by exchange cleared product and the ability to access the insurance market with a bit of leverage due to the margin benefits of futures contracts."

"There will be a shift towards more volume traded on the exchanges, it is a question of when, not if," he said.

This week’s BLOG looks at the barriers to trading volume and the benefits of using the exchange. See the BLOG, click here.

Nephila Capital ILS catastrophe fund raises further $340m

2010-03-09T19:01:00.000-08:00

Bermuda-based Nephila Capital, an investment manager specialising in insurance-linked securities, attracted inflows of USD340m from 11 UK institutions into its catastrophe reinsurance fund in the second half of 2009 according to this Hedgeweek article:

The latest inflows bring total assets under management in the platform to USD2.6bn.

Nephila, in which Man Group has a 25 per cent stake, has multiple investment products and managed accounts dedicated to investing in insurance-linked instruments such as catastrophe bonds.

Catastrophe bonds are a form of insurance securitisation that spreads the risk of insured claims from large natural disasters, such as hurricane Katrina. Because returns on these instruments are based on physical events instead of market events, they offer investors access to an asset class which is totally uncorrelated to world stocks and bonds.

“Insurance-linked securities are clearly gaining broader acceptance from institutional investors and consultants,” says Paul Dackombe, head of UK institutional sales at Man,
“After the recent financial market turmoil, institutional investors are actively seeking return streams that are independent from the capital markets and catastrophe reinsurance certainly provides that portfolio benefit.”

Greg Hagood, co-founder of Nephila, says: “Insurance payouts for damages caused by hurricanes Gustav and Ike and the heavy investment losses and liquidity constraints brought about by the financial crisis have led to a major market shake out. Remaining participants, such as Nephila, have therefore been able to capitalise on this opportunity and charge higher catastrophe premiums.”

Nephila has bolstered its senior management team with the appointment of two new partners, Steve Glassman and Adolfo Pena, who will help support the ongoing growth of the business.

Glassman joined on 1 February 2010 as a managing partner after more than 20 years with Merrill Lynch. He will focus on strategy, product structuring and the management of human resources and business processes.

Pena, a portfolio strategist and seismic and financial engineer, joined Nephila in 2005. He will continue to co-manage the portfolio management and analytics group.

The FSA is not a fan of life settlements

2010-03-08T10:48:00.000-08:00

Original posted on FT Alphaville by Stacy-Marie Ishmael:

Add the UK’s financial services regulator to the cacophony of voices expressing concern about so-called life settlements.

First, a definition of the term, via Standard & Poor’s:

Life settlements, sometimes referred to as senior or elder settlements, involve the purchase of life insurance policies from individuals, typically age 65 and older, who have various ailments or suffer from a particular disease and whose projected life expectancy is typically between two and 10 years.

(Also worth pointing out that there are significant differences between life settlements and viatical settlements — which are policies taken out by someone with a terminal illness; ‘death bonds‘, or life settlement securitisations, are another issue entirely.)

Below are extracts from a rather blunt speech by Peter Smith, head of Investments Policy at the UK regulator’s Conduct Policy division, on the vexed matter of ‘traded life policy investments’.

Any emphasis FT Alphaville’s:

I would like to cover the FSA’s position on the inherent risks and issues of Traded Life Policy Investments (TLPIs). We use TLPI as a collective term for any products that invest in Traded Life Policies, Senior Life Settlements or Viatical Settlements.

The FSA views TLPIs as complex products with a number of inherent risks. We do not see them as mainstream products. I was interested to note – from your Agenda – an expectation that it should be “sophisticated investors” who are entering this market – we would not disagree with this. From our supervisory work we do have some significant concerns in the way these products are brought to the market at present. We have had to take action with a number of firms already and so we would be very concerned to see a rapid increase in the size of this market.

…

We are concerned that some providers are not proactively highlighting the particular risks with this type of investment to advisers, instead supplying them with only basic information and awaiting further questions. If individual complexities and risks are not being adequately explained to IFAs, there is a risk that important features of the products may not be relayed to customers.

I have mentioned stress testing of products. Providers need to understand in which circumstances the product will deliver as expected and, crucially, in which circumstances this does not hold true. They also need to take a realistic view of the likelihood of these different circumstances materialising.

I have heard a fund provider say that “the product was a good product, it was just that the market moved against us” as if the performance of underlying assets or markets should be seen as a surprise. The product provider also needs to make clear to any distributor their expectations of the situations in which the product will and will not deliver.

…

I’m sure that over the course of your discussions you have talked about the features of TLPIs that make them the right product for investors. The product should, it might be argued, stand or fall on its own merits.

So it is a matter of great concern to us that we see commission rates being offered to advisers which are well out of line with market norms.

I would ask the providers in the audience – if it’s such a good product, why do you need to pay people so much to sell it?

I would ask the advisers in the audience – can you be certain that what you are recommending is in your client’s best interests, given the amount you stand to gain from the transaction?

…

My concluding remark is that the TLPI market is one in which the FSA has particular interest. We do not see it as mainstream and our work to date has found significant problems in it.

Peter Smith delivered the above speech to an audience at the a conference held by the European Life Settlement Association in London on February 24. Not quite what they were expecting, mayhaps?

Insiders forecast a sunny future for CME's new snowfall derivatives

2010-02-28T06:01:00.000-08:00

Original posted in Medill Reports by Brendan Wilkerson:

Volatile snowfall levels in Chicago make preparations for snow-removal companies difficult.

Winter in Chicago means snow. And snow means sledding, shoveling, scraping and… binary option derivative contracts?

In December, Chicago-based CME Group Inc., began listing an expanded class of weather contracts based on snowfall levels in five cities around the country. The idea is that a business directly affected by snowfall can use the market to transfer the risk of uncertainty in weather.

"We believe the new binary options will provide customers with an efficient way to hedge potential losses on their businesses if it snows more or less than they plan. A snow removal company, for example, can better manage their loss in revenue in the event of a less-than-expected amount of snowfall during the snow-removal season," said Barry Goldblatt, managing director of CME Group Commodity, Energy and Metals Products, in a press release.

Now, almost three months after the launch with the snowiest stretch of winter in the rearview mirror, the market hasn’t exactly exploded. In fact, there have only been three trades, exchanging a total of 62 contracts. That’s low even for weather derivatives, which account for a small fraction of overall exchange volume.

But don’t be fooled by the low numbers, experts say. According to Jeff Hodgson, president of Chicago Weather Brokerage LLC, “In the weather space, this is one of the more successful launches. The amount of interest is extraordinarily high but there is a very steep learning curve and we’re just at the beginning of that.”

Hodgson points to the hurricane-based contracts offered by the CME as an example of how these markets can develop.

“Hurricanes traded zero for the first year--the next year they traded 35,000 times.”

Hodgson brokered the three trades that took place over the last two months on behalf of the hedgers or end-users who are looking to mitigate their risk against unexpected weather.

“End-users are those who have a wholesale exposure to too much or too little snow,” Hodgson said. “That could be ski resorts, government agencies, salt suppliers, snow removal companies, snow mobile manufactures… or suppliers to the snow industry –from something as small as an ice scraper to as big as a front-end loader.”

For these types of parties, uncertainty in winter weather, particularly snowfall levels, presents an inherent risk. A snow removal company provides the most straightforward example.

In order to do their job, these companies must have all their supplies and labor on hand to effectively respond when snow hits. Most of these firms set up contracts in the spring and summer in which they commit to removing snow the following winter.

“They’re going to have fixed costs with getting the contract, meaning staff, trucks, salt, gas,” said Clinton Kripki, director of environmental markets for boutique brokerage Choice Environmental. “If snowfall is low, they won’t meet those costs.”

Mike Riddle, a manager at Chicago-based snow removal firm Snowbiz Inc., said some supplies are stored but others can’t be and the company is forced to absorb the cost, hurting its bottom-line. “[Salt] gets wet and evaporates. You could have 100 tons at start of summer and then only have 40 tons left by winter,” Riddle said.

On the opposite end of the spectrum, if snow levels are much higher than expected, extra staff is hired, overtime is paid and additional supplies are purchased. All of these factors increase overhead, which is generally higher once winter begins, leading to declining revenue margins.

The first snowfall contracts were listed in 2006, futures contracts based on snowfall at Boston Logan International Airport and New York Central Park. CME now offers six snowfall contracts based on weather data from six locations, in five U.S. cities: Boston, Chicago, Detroit, Minneapolis and two in New York.

The suite includes futures and options, but so far only two of the contracts have traded: the seasonal and monthly binary options.

Basically, a snowfall binary option allows end-users to protect themselves from extra expenses if snowfall is outside of expectations.

If a snow removal company has supplies to plow up to a certain amount of snow it can buy a binary options contract with a strike point at that level of snowfall. If snowfall is above the strike point, the company can “call” the option and is paid a fixed-dollar amount for whatever the contract specifies. That money can be used to cover extra expenses in the case of too much snow. If snowfall is below the strike price, the option simply expires worthless.

On the opposite side, if a company uses “pay per event” contracts in which they’re paid for each time their services are used, they could hedge against the possibility of too little snow by selling binary options. If snowfall is low, the premium they received from selling the options supplements the bottom line. If snow is piling up, they pay out on the option but have increased revenue with which to do so.

In essence, these contracts function as an insurance policy against potential losses if snow levels inhibit business or profit margins.

Though Snowbiz has an umbrella insurance policy covering risk in everything from workman’s compensation to liability on its vehicles, Riddle said it does not include anything that specifically addresses weather risk.

However, insurance policies like that do exist.

“I can create a policy that accomplishes the same time of risk mitigation that the traded contracts will solve, protection against too much snow or too little snow,” said Rob Holmes, vice president of marketing for MSI GuaranteedWeather LLC and its subsidiary of Vortex Insurance Agency LLC.

GuaranteedWeather participated in the first trade of snowfall contracts and plans to continue to participate in traditional insurance policies and market solutions.

“The onus is really on the individual company. By us having both available we give the potential client the option,” said Holmes.

Though this type of insurance policies is not new, most companies, like Snowbiz, are not using them.

“I would say in 95 percent [of the companies], if not 99 percent, they’re not using insurance,” said Hodgson. “In most cases, [companies] that are using insurance policies are using it for catastrophic events, once-in-one-hundred-years type of stuff.”

Despite the lack of popularity in traditional snowfall insurance, Hodgson and Kripki believe the derivative contracts offer a different, more attractive option that will drive trading.

For one, the market provides a degree of transparency that is not always available in insurance policies. A derivatives market allows for price discovery and uniformity in competition rather than dealing with a lone insurance provider.

“Here they can get more quotes and a wider range,” said Kripki, who served as the broker opposite Hodgson on the first three snowfall contract trades. “You go to one insurance company and they have specifications [while] another company has other specifications; here its apples to apples.”

Beyond transparency, derivatives contracts offer greater flexibility than traditional insurance policies because customers can enter or exit a contract at any time.

“Derivatives are tradable, you can buy and later sell it,” GuaranteedWeather’s Holmes said. “When you buy an insurance policy, you own it until its expiration.”

Finally, Hodgson points out the high level of security that comes along with dealing through an exchange as large as the CME Group, the world’s largest derivatives marketplace. Every trade on the market is cleared through and backed the exchange, all but eliminating the possibility of default--a level of confidence that Hodgson says no longer exists with insurance companies after the last two or three years of financial turmoil.

“Any insurance company can default on risk but when you deal with an exchange you have multiple layers of protection,” Hodgson said. “The CME is the buyer to every seller and seller to every buyer.”

Holmes agrees that derivatives are a different product than traditional insurance, but says his company will continue to offer insurance policies directed at the same risk. An insurance policy, he said, is much more straightforward and simple than derivatives.

“A snow contractor might be able to find transparency by trading on the CME, but they might not understand or be eligible to trade on the CME,” said Holmes.

He also pointed out that municipalities, which have a great deal of costs tied up in snow removal, often avoid market-based hedging and may be more interested in traditional insurance.

“My experience is most municipalities have a barrier against derivative contracts, so having an insurance policy for the city of Chicago or city of Naperville gives them the option to mitigate risk of heavy snow.”

That said, GuaranteedWeather’s participation in the inaugural trades evidences its support for the development of the snowfall derivatives market.

“For any market to grow you need to have participants,” Holmes said. “We’re certainly on board for growing all types of weather trading.”

A simple point, but participation is crucial to the success of any market, and according to Kripki, that participation must start with hedgers: “You need end-user demand to drive market.”

In the three trades that have taken place on the snowfall contracts, Kripki represented the more speculative side. He works with hedge funds, investors and insurance companies like GuaranteedWeather, that are familiar with derivatives markets.

Recruiting end-users is a little trickier, as many who fit that mold are not market veterans. For Hodgson, its means teaching before pitching.

“A huge part of my job is education,” Hodgson said. “It’s sending out mailings, it’s speaking engagements, and I’m in meetings constantly with people. Education is 90 percent.”

On Tuesday, Hodgson hosted an online seminar on snowfall contracts with more than 60 participants and already has 10 speaking engagements lined up this year. Hodgson’s excitement about the future of the market comes from the level of interest among potential customers.

Attendance on Tuesday was double the last Webinar and Hodgson estimates he’s had between 200 and 300 conversations with interested end-users.

“I can assure you there is a large, large demand for this,” Hodgson said. “It’s my job to educate people enough to start participating.”

Hodgson not only offers Webinars and speeches, he also meets with individual companies to demonstrate how the snowfall options can boost their bottom line and how Chicago Weather Brokerage can help in navigating the market.

“It’s a three-step process: educate them on the basics of market, show them how to apply it to their business, and then get them to make an investment and participate.”

Riddle and Snowbiz represent the perspective of many potential end-users in that they are not opposed to the idea, but simply are unfamiliar with it.

“It’s something the ownership would be interested in looking at, but it’s the first time I’m hearing of it so we’d need to learn more about it before I commented on it,” said Riddle.

Kripki echoes that at this point the key component is education. He and Hodgson are confident that once companies are exposed and informed about the contracts, volume will snowball.

“Once some people are using it, word begins to spread,” Kripki said.

Hodgson believes the potential is there for increased momentum to carry this market to the point that it changes the way companies manage risk.

In five, 10 years, I don’t see it as a nascent market, I see it changing the way companies do business,” Hodgson said. “This is not just a risk management tool, this is a marketing tool.”

By minimizing the risk of unexpected weather, it could change the way snow removal companies bid on contracts or provide opportunities for ski resorts to base pricing on levels of snowfall.

Though Hodgson’s predictions for that kind of market growth are admittedly a few years away, he doesn’t think it will be a long wait to see the seeds begin to sprout.

“I expect exponential growth next year,” Hodgson said.

Paternoster and Deutsche Bank's Pension Scheme Insurance Deal

2010-02-22T20:52:00.000-08:00

Paternoster Press release: Deutsche Bank's wholly-owned insurance company, Abbey Life, has announced today that it has executed the largest ever longevity insurance transaction. This transaction will provide the BMW (UK) Operations Pension Scheme with a hedge for life expectancy risks associated with nearly £3 billion of pension scheme liabilities related to approximately 60,000 pensioners.

Abbey Life utilised the proprietary longevity modelling techniques and structuring expertise of Paternoster, the specialist pensions insurer in which Deutsche Bank is the largest shareholder. Through the transaction, Abbey Life will insure longevity risks of the BMW pension scheme while spreading a proportion of the risk to a consortium of reinsurers (including Hannover Re, Pacific Life Re and Partner Re). Unlike other longevity products, Abbey Life's longevity hedge has been constructed to provide the flexibility to adjust the specific benefit structure and hence better match the longevity risk of the scheme.

BMW chose to insure this risk in order to protect the sponsor against a financial risk in its UK pension scheme.

Nardeep Sangha, CEO of Abbey Life said: "In bringing this leading solution to BMW and its UK pension scheme, we have demonstrated our ability to combine our balance sheet strength and internal expertise with the specialist pensions and longevity know-how at Paternoster to bring about a landmark transaction. As this market develops we are committed to providing innovative solutions to UK pension schemes."

Rashid Zuberi, Abbey Life's Chief Risk Officer and Head of Complex Life and Pensions Management at Deutsche Bank said: "We are extremely proud of the hedge we designed in conjunction with the scheme's trustees and their advisers, Hewitt. Through the utilisation of innovative structuring and reinsurance capacity we have been able to manage the overall risk of the transaction to deliver a cost effective way for the scheme to mitigate a large and complex risk. With this latest transaction, Deutsche Bank demonstrates that it now offers pension schemes the most comprehensive range of risk management solutions in the market."

Ed Jervis, CEO of Paternoster said: "UK pension schemes are increasingly looking to reduce risk and increase security for their members through the use of insurance solutions. This transaction represents a ground-breaking precedent in the rapidly growing market for insurance against longevity risks and is a demonstration of the flexibility and innovation which Paternoster continues to bring to this market. The complexity of a transaction this size should not be underestimated and is only possible through a combination of highly specialised skills, flexibility and, above all, a thorough understanding of the trustees' objectives."

Martin Bird, Principal and Head of Longevity & Risk Solutions at Hewitt Associates said: "Entering into a bespoke longevity hedge to mitigate against continued improvements in member life expectancy is a natural extension to the scheme's current liability matching investment strategy and is designed to enhance further the security of members' benefits. We have worked closely with the trustees to run a competitive tender process and to ensure that the product structure is right for the scheme. This transaction sets a new benchmark for managing longevity risk and will pave the way for a number of schemes to follow suit. With a continued focus on pension risk management, we expect to see the market for similar transactions scale new heights in 2010."

Should you want further information please contact Myles Pink on 020 3040 5558 or Sammy Cooper-Smith on 020 3040 5557

Paternoster is an FSA regulated insurance company specialising on the risks associated with companies' final salary/defined benefit pension schemes.

Its sole focus is on providing tailor-made solutions for pensioners, their employers and trustees. Its objective is to ensure long term security for scheme members whilst delivering the highest level of customer care.

Paternoster was authorised on 27 June 2006 after securing £500 million of equity financing from a number of institutions (including Deutsche Bank and Eton Park International LLP).

Longevity swap market to hit £10bn in 2010 – report

2010-02-22T04:44:00.000-08:00

Original posted on Reuters by Sarah Hills:

More UK companies will follow Cadbury and RSA this year by offloading defined benefit pension scheme liabilities, doubling the volume of deals done last year to 15 billion pounds ($23.53 billion), according to a report by consultants Hymans Robertson.

Last year, the market was boosted for the first time by 4.1 billion pounds of longevity swaps, a way of cutting pension risks which companies can adopt while schemes are in deficit.

“We are aware of two other longevity swap deals worth well in excess of 1 billion pounds which we expect to complete in the first half of 2010, subject to contracts,” said the report, which was released on Wednesday.

“Based on the level of activity we are currently observing, we would not be surprised to see longevity swaps cover liabilities in excess of 10 billion pounds during 2010.”

The buy-in and buy-out market was dominated by Pension Insurance Corporation, Legal & General, MetLife, Lucida and Rothesay Life during 2009 and this looks set to continue in 2010, said Hymans Robertson.

During 2009, the value of buy-ins was more than three times the value of buy-outs (2.8 billion pounds of buy-ins versus 0.9 billion pounds of buy-outs). Market activity (for buy-ins and buy-outs) increased through the latter half of 2009 with 1.2 billion pounds of deals completing in Q4, the report said.

Last year, Swiss Re’s longevity swap in a deal with the Royal County of Berkshire Pension Fund was the first transaction by a public sector pension scheme. The longevity swap covers around 1 billion pounds of its pensioner liabilities. Also, Credit Suisse completed a final longevity swap with a third of Babcock International’s pension schemes.

So far this year, it has been reported that Abbey Life, in partnership with its parent company Deutsche Bank, and Paternoster is nearing completion of a longevity swap covering around 2.5 billion pounds of BMW’s UK pension scheme’s liabilities. Also, Premier Foods have been reported to be in negotiations over a longevity swap deal covering around 2 billion pounds of Rank Hovis McDougall’s pension scheme’s liabilities.

To see the full report, click here.

Deutsche Bank to take on £3bn BMW UK longevity risks

2010-02-22T04:32:00.000-08:00

Original posted in the Financial Times by Paul J Davies:

Deutsche Bank is to take over the longevity risks of nearly £3bn of pension liabilities from BMW’s UK scheme in what will be the largest deal ever done in corporate longevity insurance, in effect doubling the size of the market overnight.

The deal, to be announced today, is being carried out through the bank’s insurance subsidiary, Abbey Life, and was structured in partnership with Paternoster, the specialist pensions business 40 per cent owned by Deutsche.

The market for pension schemes to offload longevity risks – the costs of pensioners living for longer than expected – is expected to grow rapidly this year as more and more UK schemes look to reduce the cost and volatility of their defined benefit schemes.

Martin Bird, head of longevity and risk solutions at the consultants Hewitt, which advised the trustees, said the BMW deal would pave the way for a number of schemes to follow suit. “With a continued focus on pension risk management, we expect to see the market for similar transactions scale new heights in 2010,” he said.

Hymans Robertson forecast that more than £15bn of pension risks would be passed from corporate schemes to financial companies in 2010 and that about £10bn of that would be longevity swaps or insurance.

The market is attracting more new entrants. Last week Legal & General became the latest to say it would offer longevity insurance, competing with companies such as Pension Corporation, Swiss Re, Credit Suisse, Goldman Sachs and UBS.

There is a newly formed trade body, the Life and Longevity Markets Association, which aims to create an international market where insurers themselves can hedge out longevity risks when taking on corporate pension risks.

At the moment, only a handful of reinsurers are prepared to take these longevity risks, limiting the potential capacity of the market.

Much of the risk in the BMW deal will be passed on to Hannover Re, Pacific Life Re and Partner Re, according to Nardeep Sangha, chief executive of Abbey Life.

“With this deal we were pushing on the boundaries of the capacity that is available for a single transaction, but we think it is expanding and new names are coming in,” he said.

Pension Crisis is a Myth? Not for Nortel Disabled!

2010-02-17T21:36:00.000-08:00

Original posted on Pension Pulse:

I promised to shift my focus back to pensions. Jack Mintz wrote an article yesterday in the National Post claiming that the pension crisis is a myth:

The myth that the pension system is in crisis grew out of the 2008 financial crisis. Canadians saw an average 20% loss in their portfolios. Pension plans had a similar experience with some becoming insolvent. Nevertheless, a 2009 DBRS survey of 70 defined benefit plans showed that most pension plans were in relatively good shape. The OECD has ranked Canada’s pension system as one of the most sustainable in the world with elderly Canadians having disposable income equal to 95% of working Canadians, third highest of industrialized economies. The poverty rate among the elderly — less than 5% — is one of the lowest among OECD countries

Household net worth at the end of the third quarter of 2009 is six times disposable income, roughly the same as in 2000 at the height of the high-tech boom. Canadians have $5.9-trillion in net assets, including $2-trillion in Canada/Quebec Pension Plan assets, Registered Pension Plans and RRSPs. Housing and real estate equity accounts for another $1.9-trillion and other financial and non-financial assets, net of consumer debt, total $2-trillion (the latter is likely underestimated since Statistics Canada measures private corporate shares at book, not market value).
Given that pension and RRSP withdrawals are fully taxed, Canadians have more retirement assets in the form of housing or financial assets than they do in pensions or RRSPs. These other assets, including housing that can be downsized at retirement, cannot be ignored in any assessment of retirement income adequacy. Certainly, the system is not perfect. But there is no pension crisis. Ask the provincial ministers of finance after surveying the evidence. Dwight Duncan, Finance Minister of Canada’s largest province, was pretty clear about this point after the December Whitehorse meetings.

The claim that Canadians are not saving enough is generally not true — at least 80% are saving sufficiently for retirement. As several studies concluded, Canadians with less than $40,000 have been well protected by government transfer programs, the C/QPP and tax policies with retirement income adequacy at 90% or better. High-income Canadians (those with more than $100,000) have lower replacement income (ranging from 50% to 70%). However, the OECD argues that 50% replacement income at retirement is often adequate for upper-income households, much less than the 70% typically claimed.
The middle-income group is the current focus. But here studies, once incorporating other financial assets besides pensions and RRSPs, show that most have adequate levels of retirement support. The best study by Statistics Canada suggests that about a fifth to a quarter of middle-income Canadians (about 600,000 retirees) have inadequate retirement income below 60% of after-tax working income.

However, the analysis does not incorporate tax-free housing and private corporate assets, which are significant retirement assets. We also do not know how much of this middle-income group with low retirement income has lost jobs during their career, suffered from family breakups, arrived to Canada late in their working lives or have significant assets tied up in their own private business whose income is not included in tax files. This information is needed to figure out the best policies to address any shortfalls.

The third myth is that Canadians must have an occupational pension plan to have adequate retirement savings. A recent Statistics Canada study by Ostrovsky and Schellenberg published late in December raises serious doubts about this claim. The authors show that individuals without occupational pensions have better replacement income at retirement than those who do. Obviously, the investment returns net of fees for various saving instruments have not undermined the ability to ensure adequate retirement income. Even if one ignored employment earnings after the age of 65 (people without RPPs work more in later years), Canadians without pensions have more RRSP, financial income and capital gains compared to market income of those who have a pension, regardless of income.

Some have argued that the RRSP system has failed but even this claim is not supported by evidence. Most lower-income Canadians do not always contribute to RRSPs since they have sufficient retirement income through other means. Over 60% of unused RRSP contribution room is in this category. Leaving out this group, a large proportion of Canadians contribute to RRSPs for many consecutive years. Compared to pension funds, RRSPs provide flexibility to savers since the funds could be used for family emergencies and other contingencies without being locked-in.

Some argue that, unlike existing retirees, working Canadians will have difficulty earning good investment income in the future. However, this is just an assertion and not based on any particular modeling. Instead, a different argument could be hypothesized. The return on assets could rise if global saving rates, expected to decline due to heavy indebted governments and aging in industrialized countries, are inadequate to support abundant capital spending on infrastructure, alternative energy supply and economic growth in emerging countries. With excess demand for saving, the return on investment rises, making it easier to fund retirement needs. Certainly, no easy conclusion can be reached without better analysis.

Overall, Canadians have shown that they have made good decisions for themselves. True, some Canadians might have inadequate savings for their retirement and the system could always be made to perform better than now. Those issues will be addressed by Ministers in the future. In the meantime, we should not panic into adopting measures that are not evidence-based.

I think someone should show Jack Mintz a recent BMO survey which showed one third of Canadians have no RRSPs and of those who do, an overwhelming majority (80%) are not confident that their RRSPs investments will provide enough for their retirement. Nearly half of the respondents feel they do not contribute enough to their RRSPs to meet their retirement goals.

But hey what pension crisis? It's all a myth according to Jack Mintz, the appointed "expert" on the subject. Why are Canada's public service unions not breathing easier after meeting with Treasury Board president Stockwell Day? Apparently he did little to assuage public servants' fears that their pay and benefits will end up on the table when the Conservatives deliver their "roadmap" in next month's budget to dig Canada out of the deficit.

But hey what pension crisis? Everything is fine and dandy according to Jack Mintz. Perhaps Mr. Mintz should step out of his Ivory tower and meet up with Nortel's disabled workers who are still fighting for a pension deal:

Nortel employees on long-term disability leave say they will fight a deal reached between the failing company, themselves and Nortel pensioners.

Some disabled employees, including Jennifer Holley and Arlene Plante, are going to Toronto to oppose court approval of the deal, which is scheduled for March 3.

Plante said she's fighting the agreement announced on Feb. 8 because it doesn't offer any protection beyond the end of 2010.

In addition, it requires employees and former employees to give up their right to sue Nortel Networks Corp. and oppose the payment of $92 million in bonuses to Nortel executives. Nortel asked U.S. and Canadian courts to approve the bonuses last week.

Plante said the payments are obscene. The company maintains that it needs to pay the bonuses in order to hold on to key employees until necessary work is complete.

"The agreement is immoral," said Diane Urquhart, an independent financial analyst who has been helping the disabled employees.

Urquhart said that money would go far if it were used instead to fund the disabled workers' health and welfare trust. However, she said, the law does not require Nortel to provide for the replacement income and health benefits of the disabled under the current circumstances.

The 400 employees on disability are in a difficult position because the 12,600 pensioners are largely satisfied with the deal.

Plante admitted that the minority of employees on disability are also poorly equipped for their fight.

"We're not lawyers," Plante said. "We don't know how to do things like affidavits and motions."

Holley expressed frustration about the position disabled employees are in.

"We've got to kill ourselves trying to get this stuff together that we have no experience with," she said.

Nortel filed for bankruptcy protection in January 2009 and since then, most of the company has been sold off.

On Feb. 8, the company announced it had reached a deal with its pensioners and its employees on disability leave, who feared they would lose their benefits when the company is finally dissolved. The agreement includes a commitment from the company to pay long-term disability benefits and pensioners' health benefits until the end of 2010.

In addition, workers who were laid off without severance will each get a $3,000 lump-sum payment. The company will continue to administer its pension plans until the end of September, and then a new administrator will be appointed.

The pensioners, who are facing a $2.5-billion shortfall in their pension plan, are also partially protected by the Ontario government. Finance Minister Dwight Duncan announced Feb. 7 that the first $1,000 of their monthly pension payments will be guaranteed under an emergency pension insurance fund.

Diane Urquhart is absolutely right, this agreement is downright immoral. She has done an exhaustive analysis of the agreement, Nortel Disabled Bulldozed into Accepting Poverty for Life and Bonuses for Executives. Diane sent me this message:

My main conclusion is that this Feb. 8th agreement is offering life to the long term disabled employees in the short term of 2010, provided they agree to live in poverty for the rest of their lives and agree to not oppose the Nortel executives and key employees getting the additional incentive payments that were announced on Feb. 8, 2010. John Doolittle, Corporate Leader of Nortel, is providing scraps off the table for the LTD employees, while protecting his own $1.7 million compensation for each year of 2010 and 2011. The 418 LTD employees are having their lives and quality of life sacrificed by the acceptance of this Feb. 8th agreement for the benefit of the 17,749 Nortel Canadian pensioners, the Nortel executives and key current employees, the U.S. junk bond owners and other large unsecured creditors.

The reasons for my conclusions are set out in the new report.

I plan to make additional communications to you about the steps that dissenting LTD employees will be undertaking in order to correct the mistakes that have been made in this Feb. 8th agreement affecting them before this matter comes to court on March 3rd. Fortunately, there is a process for the LTD employees who decide to oppose this Feb. 8th agreement to do so by filing a Notice of Appearance by 10:30 a.m. Eastern Time on March 1st. The LTD employees are now forced to hire independent legal counsel at their own expense and I am getting calls from LTD employees who are not well enough and cannot afford to send independent legal counsel to be heard in court on March 3rd.

Ideally, the Feb. 8th agreement will be amended before this Notice of Appearance submission deadline so that the stress on the Nortel LTD employees will be contained and there are no personal crises that result from it.

But who cares about Nortel's disabled? Certainly not Jack Mintz or even those other Nortel pensioners that cut a deal for themselves and left their disabled colleagues out to dry.

If you want to see the reality of many disabled in Canada, look no further than the story of Sharon Segal who was diagnosed with Multiple Sclerosis almost 35 years ago. Like far too many other disabled Canadians, Sharon is caught in the disability poverty trap.

But hey, it's all a myth, there is no pension crisis according to the Jack Mintzes of this world. Give me a break! Have they no shame in making such silly declarations?

L&G prepares to offer funds ‘longevity insurance’

2010-02-17T21:34:00.000-08:00

Original posted in the Financial Times by Paul J Davies:

Legal & General is to take on the likes of Goldman Sachs, Credit Suisse and Deutsche Bank by offering “longevity insurance” to pension funds.

It is likely to foreshadow similar launches by Prudential and others in the sector.

Tim Breedon, L&G chief executive, said the business – which would protect pension funds against the costs of its pensioners living longer than expected – was not a replacement for the more traditional bulk annuity or pensions buy-out markets.

He said: “Longevity swaps will develop alongside and not necessarily compete with our bulk annuity business,”.

UK pension schemes are expected to offload more than £15bn of liabilities this year as they seek to reduce the costs and volatility of their defined-benefit plans. Two-thirds of this is forecast to take the form of longevity swaps, according to research by Hymans Robertson, the pension consultant.

Babcock International and RSA became the first companies to take out longevity protection last year with Credit Suisse and Rothesay Life, a unit of Goldman Sachs, covering liabilities worth £3.1bn. BMW is in discussions with Deutsche Bank over a longevity insurance-type deal, which is expected to cover more than £2.5bn of liabilities.

Simon Gadd, L&G’s managing director for annuities, said such deals would involve larger pension schemes because of the time and resources required. L&G’s main focus has been on buy-outs for smaller plans.

The pensions buy-out business, which takes the full risks of paying pensions off the hands of a company scheme, fell by more than half from £194m of new business in 2008 to £88m last year as the overall market declined by about 50 per cent.

However, Mr Breedon said this market “has got to grow” because of the weight of more than £1,000bn of defined-benefit pension liabilities borne by the private sector.

L&G’s move came with a trading update showing total full-year sales roughly in line with forecasts at £1.39bn for 2009, down 7 per cent on an annual premium equivalent basis.

Mr Breedon said cashflows would be at least £200m ahead of its £450m target announced at the start of 2010.

Scientists discover the secret of ageing

2010-02-15T19:44:00.000-08:00

Original posted in the Financial Times by Clive Cookson:

One of the biggest puzzles in biology – how and why living cells age – has been solved by an international team based at Newcastle University, in north-east England.

The answer is complex, and will not produce an elixir of eternal life in the foreseeable future.

But the scientists expect better drugs for age-related illnesses, such as diabetes and heart disease, to emerge from their discovery of the biochemical pathway involved in ageing.

The Newcastle team, working with the University of Ulm in Germany, used a comprehensive “systems biology” approach, involving computer modelling and experiments with cell cultures and genetically modified mice, to investigate why cells become senescent. In this aged state, cells stop dividing and the tissues they make up show physical signs of deterioration, from wrinkling skin to a failing heart.

The research, published by the journal Molecular Systems Biology, shows that when an ageing cell detects serious damage to its DNA – caused by the wear and tear of life – it sends out specific internal signals.

These distress signals trigger the cell’s mitochondria, its tiny energy-producing power packs, to make oxidising “free radical” molecules, which in turn tell the cell either to destroy itself or to stop dividing. The aim is to avoid the damaged DNA that causes cancer.

The Pensions crisis
FT multimedia feature: The dilemmas faced by individual savers, companies and governments and offers potential solutions to the pensions time bomb

The Newcastle discovery plays down the role of telomeres, the protective tips on the ends of human chromosomes, which gradually become shorter as we grow older.

“There has been a huge amount of speculation about how blocking telomere erosion might cure ageing and age-related diseases,” said Tom Kirkwood, director of Newcastle’s Institute of Ageing and Health. “The telomere story has over-promised and the biology is more complicated.”

He added: “Our breakthrough means that we stand a very much better chance of making a successful attack on age-related diseases while at the same time avoiding the risk of unwanted side-effects like cancer.”

His colleague Thomas von Zglinicki emphasised caution in the research’s next stage – to investigate ways to prevent cellular senescence.

“It is absolutely essential to tread carefully in trying to alter processes that cause cells to age, because the last thing we want is to help age-damaged cells from breaking out to become malignant,” said Mr von Zglinicki.

Catastrophe Bond Market Continues to Improve

2010-02-15T09:20:00.000-08:00

Original posted on GCCapital.com:

Despite the challenging financial conditions of late 2008 and early 2009, the catastrophe bond market continued to play a critical role for both sponsors and investors over the past 12 months. Throughout the year, as financial markets stabilized generally, catastrophe bond issuance conditions continued to improve. In 2009 USD3.4 billion of risk capital was issued through 18 transactions. In terms of risk capital, this is a 25 percent increase over 2008. After declining over the first two quarters of 2009, total catastrophe bond risk principal outstanding increased from USD12.0 billion at year-end 2008 to USD12.2 billion at year-end 2009, reflecting a particularly strong fourth quarter for issuance.

Pricing and capacity conditions in the cat bond market were dramatically different between the first and second halves of 2009. In the first and second quarters, with the turmoil of late 2008 still a dominant concern, cat bond pricing was in some cases up nearly 50 percent relative to early 2008, remaining elevated relative to both historical precedent and the traditional reinsurance market.

In the third and fourth quarters, pricing declined 25 percent to 40 percent and, depending on transaction features, is now tracking with 2007 levels. Drivers for this market reversal include: stabilizing financial conditions generally; elevated pricing in the first half, forestalling planned issuances (as some sponsors were reluctant to issue into a distressed environment); cat bond maturities and net new inflows to the asset class generating investable cash; and the acknowledgment by market participants that the spread levels of early 2009 were unsustainable when ample traditional reinsurance capacity remained available at far cheaper pricing.

Heading into 2010, the catastrophe bond market continues to provide an increasingly attractive and worthwhile supplement to sponsors’ risk transfer programs. Aside from what could potentially prove to be attractive levels to lock in fixed pricing on a multi-year basis, other transaction features such as trigger mechanics and choice of collateral solution (among other features) continue to progress and offer greater value to protection buyers and sellers. The market also remains focused on further reducing transaction costs and transaction time requirements in order to improve the overall efficiency of catastrophe bond risk transfer solution.

Cat bond maturities nears $2 bln in first quarter

2010-02-15T06:10:00.000-08:00

Original posted on Reuters by Sarah Hills:

A total of nine catastrophe bonds have matured in the first quarter of 2010, with a combined capacity of approximately $1.8 billion, according to Reuters' data.

Catastrophe bonds are used by the insurance industry to transfer extreme risks, such as those for earthquakes or hurricanes, to financial market investors, who receive a good risk-adjusted return for agreeing to cover damages they consider unlikely.

Of the $1.8 billion total, $508 million has come back into the market on related issuances. The capacity released by five of the nine bonds was partially covered or totally absorbed by the related transactions the final quarter of 2009. So far in the first quarter of 2010, only one bond has closed.

Foundation Re III, The Hartford's $180 million U.S. hurricane cover, was the first bond to close in 2010 and partly replaced Foundation Re D's $105 million transaction, which covered U.S. wind and U.S. earthquake.

Swiss Re's $75 million bond, Vita Capital IV, closed in November, which partly replaced the reinsurer's previous mortality bonds, Vita Capital II and Vita Capital III, priced at $362 million and $100 million respectively.

The 120m Euro Atlas Re III transaction expired on January 10, with 75m Euro of European windstorm and Japanese earthquake capacity already having been placed back in the sector in December by French reinsurer SCOR in the form of Atlas Re VI.

Successor Hurricane IND's $60 million U.S. wind bond was covered by the much larger Successor X, which was closed by Swiss Re in December for $150 million.

For information on outstanding natural catastrophe bonds, click here.

At the end of 2009, the Lane Financial Synthetic Rate on line Index, which measures the price of insurance risk in the capital markets, stood at 142.2, which is around the same level as the first quarter in 2007 (137.9 index rate). The year 2007 was the cat bond's sector most prolific year, ending on $7 billion in issuance (see http://communities.thomsonreuters.com/ILS/427588).

As the price of insurance risk in the capital markets falls, partly driven by increased demand from investors looking for a diversifying asset class, cat bond issuance will become increasingly attractive to potential sponsors.

The four bonds that have matured and have not yet seen any related issuance are:

Calabash Re II which expired January 10, its three tranches covering U.S wind, U.S. earthquake and U.S. wind and U.S. earthquake respectively, totalling $250 million.

Carillion's $51 million U.S wind cover from Munich Re which also expired January 10.

Nephila Capital's $265 million multi-peril bond, Gamut Re, matured on January 31. Its four tranches each cover U.S., European and Japanese wind and U.S. and Japanese earthquake. Gamut Re's fifth tranche, covering the same multi-perils, will expire July 31, 2011.

Osirius Capital, AXA'S extreme mortality bond matured January 15. The four tranches are split - two tranches totalling 150 million Euros and the other two $250 million.

Goldman Sachs has also overtaken Swiss Re, the world's second biggest reinsurer, as the number one lead manager for outstanding issuance in 2009, compared to 2008, according to Reuter's data (http://communities.thomsonreuters.com/ILS/492510).

Goldman Sachs had 51 bonds outstanding where they had been Lead Manager totalling $5 billion compared to 45 issuances and $4.59 million in 2008. Whilst Swiss Re had 62 bonds outstanding by end 2009, this amounted to $4.67 billion and compared to 63 issuances valued at a total of $4.92 billion in 2008.

Michael Halsband, vice president at Goldman Sachs noted that $2.7 billion of transactions will mature in the first half of the year, and most of that is expected to be placed straight back into the ILS sector.

"In addition, we believe between $1.5 - $2.5 billion of new capital has flowed into dedicated ILS funds and along with the $2.7 billion of maturities, around $5 billion will be available to be put to work in the cat bond sector," he said.

Pension players look to ILS to hedge longevity risk

2010-02-15T06:08:00.000-08:00

Original posted on Reuters by Sarah Hills:

Pension plans and insurers are increasingly looking to the capital markets and the Insurance-Linked Securities (ILS) sector to hedge longevity risk as the exposure becomes too big for reinsurance to handle.

Pension funds and insurers are increasingly exposed to longevity risk as life expectancy continues to rise worldwide and pension systems are increasingly being privatised. Total pension liabilities exceed $19 trillion in the U.S. and $3 trillion in the UK, according to figures from the International Financial Services London (IFSL).

The gathering momentum of pension players looking to transfer longevity risk has driven the desire to develop standardised products and indices to attract investors from the capital markets and ILS sector to invest in the exposure.

Given the duration of these liabilities, an increase of one year in longevity from current expectations could cause a three percent increase in liabilities, translating into a financial risk of around $600 billion in the U.S. and $90 billion in the UK, said the IFSL.

Longevity risk currently exceeds the size of capacity in the current insurance and reinsurance marketplaces, said John Fitzpatrick, a partner at Pension Corporation and one of the directors of the newly launched Longevity and Life Markets Association (LLMA).

"In the UK alone in the next 20 years, there is set to be a 60 percent increase in the number of retirees. This will create a huge financial risk to pension funds, governments and local authorities who run pension schemes," he said.

Pension funds are unable to diversify longevity risk and have traditionally transferred longevity in the form of buy-ins and buy-outs to pension insurers, who then underwrite price specific pension fund risk.

But last year, the market demonstrated a desire to use modern securitisation methods after three longevity transactions were completed using longevity swaps.

In June 2009, Babcock International signed a longevity swap agreement with Credit Suisse to cap 300 million pounds ($470.7 million) of its pensioner-in-payment liabilities, while RSA completed a deal with Goldman Sachs and its insurance division Rothesay Life to cover its own pension schemes.

In December last year, Swiss Re entered into its first longevity transaction with UK pension fund, Royal County of Berkshire Pension Fund, providing protection on 1.7 billion Swiss francs ($1.59 billion) of pensioner liabilities.

Last week's launch of the LLMA, which is comprised of a consortium of banks, insurers and pension funds, will develop a series of standardised indices that can be used as a global benchmark for trading longevity and mortality risk. The risk will be traded as swap structures initially, but as the market develops, longevity bonds will be created to transfer the risk.

"Some insurance companies are natural writers of longevity from pension plans, but even those insurers have a limited amount of capacity to write longevity," Costas Yiasoumi of Swiss Re, told Reuters. "The LLMA want to establish a framework to attract capital market investors to longevity before insurance capacity comes under strain."

The Pension Regulator's 2009 survey on scheme funding found that the life expectancy assumed by pension plans for their pensioners was revised upwards by 12 months on average over the two years from the start of the survey.

"For a pension plan that thought its liabilities were 1 billion pounds, that is equivalent to adding about another 30 million pounds and that needs to be funded somehow," said Yiasoumi.

The market has been talking about securitising longevity risk for a number of years, but the LLMA represents the first time a cross sector association has been launched with the single aim to create a standardised market.

Demand for longevity-linked products has increased in recent years as more pension funds and insurers look to manage their pension liabilities. Last week, BMW's British pension insurer Paternoster was reported to be working on a deal with Deutsche Bank, one of the LLMA's member company's, to hedge the company's 2.5 billion pounds UK pension risk.

"Longevity is an ideal instrument to securitise, and it has many features relevant to the fixed income market and the ILS sector," said David Rawson-Mackenzie, managing director at Centurion Fund Management, which launched its first macro and micro longevity fund in Luxembourg last year.

"The ILS market has managed to securitise hurricanes and earthquakes risks through cat bonds, and there is no reason why it can't be done with longevity.

"This is the Holy Grail for the ILS market -- after establishing a benchmark and pricing methodology to help investors understand the risk, longevity risk can become the alternative to other fixed income markets," he said.

Do not pay the ferryman until he securitises your risk factor

2010-02-09T06:05:00.000-08:00

Original posted in the Financial Times by Paul J. Davies:

Today, most people would be very surprised to know exactly who ultimately put up the funding for their mortgage. In future, we might be saying the same thing about who ultimately is paying our pension.

It has long been a dream for pension funds, life insurers and of course investment bankers to be able to trade the risks that people either live too long or die too quickly – in other words to “securitise” those risks. But successive attempts to drum up interest and activity have been stillborn.

One big obstacle has been finding a kernel of complementary economic needs. At first glance, life insurers and pension funds present a yin and yang of a natural market. However, the former wants protection against the loss of younger people who have not yet paid enough premiums, while the latter will be hurt by their elders hanging on – and on. Different lives, different risks.

Now, with companies evermore focused on the costs of their pension scheme liabilities, especially in the UK, the dream of such a market could finally be realised. A group of investment banks and insurers is working on a standardised set of products that they hope will form the fungible base of a liquid market for longevity risks. JPMorgan, one of the banks involved, is even willing to donate its own intellectual property in the form of its Life Metrics index.

The first longevity derivative trades by real pension schemes – first Babcock International and then RSA – have generated huge excitement about the market’s more than £1,000bn potential. However, such deals are likely to remain the exception, not the rule.

Instead, insurers such as Pension Corporation, Prudential and Legal & General – all founder members of the Life and Longevity Markets Association, or Llama – will need to act as transformation engines. They will have to turn the open-ended risks related to specific groups of lives into non-specific securities of certain duration.

And this points to the biggest reason why there is greater impetus for a longevity market now. Policymakers in Frankfurt and Brussels are drawing up new European capital rules for insurers – known as Solvency II. Like the Basel rules for banks, these will be governed by the principle that capital requirements should be set in line with risks taken. If insurers can demonstrate that a risk can be measured and hedged through a liquid market, it will attract lower capital requirements. The reinsurers who are stepping up their exposures to longevity risk can already hold less capital against it than the insurers they buy it from because they benefit from increased diversity.

But capital market investors will need to be careful. First, there is a classic asymmetry of information problem. Insurers have all the data and experience of mortality and longevity as it happens. They can also pool their knowledge through an analysis service such as Club Vita, run by the pensions consultants Hymans Robertson, which tells them how their own mortality experience deviates from the national picture.

Second, longevity is seen as a risk that is only realised very slowly over a long period. This is true in the sense that the pension funds and annuity providers that write very long-term contracts can find themselves repenting at extreme leisure. However, the realisation that patterns of longevity have changed can still come incredibly quickly – and so a market could change course equally rapidly.

Two specific things have led to quite sudden accelerations in the rate of longevity improvement of the baby boomers, especially among men, since the early 1990s. One was the widespread reduction in smoking once everyone knew it was a health hazard, the other was the broad use of statins, a drug for reducing blood pressure. Both significantly reduced cardiac-related deaths. The effects of each were highly uncertain at first, but became sharply apparent as groups of people kept ageing and not dying.

Given what we now know, what would the introduction of smoking bans in public places have done to longevity markets?

The more disquieting question – given public exposure to longevity risk through health and aged care budgets and public pensions – is would a government with such a ready market view of the costs of longevity have introduced a smoking ban or statins in the same way?

Ultimately, the success of a market in longevity securities will rest less on views about which way the risk is going and more on differences in how much capital different types of company must hold against the same risk.

Regulators will have the tricky task of judging whether the market is truly liquid, and of making sure they know who is really responsible for looking after us in our old age.

Plans are afoot to create a new capital market in longevity risk

2010-02-05T08:40:00.000-08:00

Original posted in the Economist:

DEATH comes to everyone. The timing is much less certain. Longevity risk, the risk that people will live longer than expected, weighs heavily on those who run pension schemes and on insurers that provide annuities. Actuaries have a track record of systematically underestimating gains in life expectancy, and more old people means a bigger bill for benefits providers. Every additional year of life expectancy at age 65 is reckoned to bump up the present value of pension liabilities in British defined-benefit schemes by 3%, or £30 billion ($48 billion).

Demand for ways to offload longevity risk is increasing, particularly in Britain, which has lots of annuities and defined-benefit pensions. Solvency 2, a pending set of rules governing European insurers, is one source of pressure: it will force annuity providers to hold more capital against unhedged longevity risk. Pension schemes, fed up with filling in deficits only to see them widen again, are desperate to manage away as much risk as they can. Many schemes have now hedged against interest-rate movements and inflation; longevity is the next thing on the list.

Simply offloading liabilities onto pension buy-out firms, which take on responsibility for schemes in return for a premium, is one option. But higher pension deficits in the wake of the financial crisis have made buy-outs more expensive. It is much cheaper to try to break off longevity risk and manage it separately. An army of bankers, insurers and consultants is at work figuring out ways to do just that.

Longevity swaps, in which investors take on the risk of paying for longer-living pensioners in return for an agreed stream of payments from the seller, are emerging as a favoured answer. Last year Babcock International became the first company to complete a longevity swap, with Credit Suisse, for three of its schemes. Others have followed. Nick Horsfall of Towers Watson, a consultancy, thinks the pipeline of potential deals could push the British swaps market to £10 billion this year, up from around £3 billion-4 billion in 2009.

Some are thinking further ahead. On February 1st a group of banks and insurers launched the Life and Longevity Markets Association (LLMA), a trade body based in London, to try to spur the development of a liquid longevity market. To date the end-buyers of longevity risk have mainly been insurers and reinsurers. They have the expertise to price the risk, but they do not have anything like the financial clout to cope with potential demand. In Britain alone, the total exposure to longevity risk is estimated by the LLMA to exceed £2 trillion. Soaking up that amount of business would require the capital markets to become interested in longevity risk, just as a market for catastrophe bonds has developed to hedge issuers against the risk of natural disasters.

Some steps toward the goal of a longevity market are easier to take than others. The LLMA wants to speed up swaps transactions (which can currently take as long as a year) by standardising documentation, for instance. It should be possible to disseminate better data on past mortality experience. But other problems are much less tractable. Predicting life expectancy accurately is the biggest obstacle to pricing longevity risk. The risk of big jumps in life expectancy may be pretty low for people who have already retired, but underwriting longevity risk for young people in defined-benefit schemes or with deferred annuities is a shot in the dark.

Nor is the scale of demand from mainstream investors clear. According to Christian Mumenthaler of Swiss Re, one of the LLMA’s founder members, reinsurers have an incentive to take on longevity risk, because they are already exposed to mortality risk (the risk of people dying too soon) through life-insurance policies. So if people live longer than expected, these businesses will see offsetting benefits elsewhere. High levels of interest from these natural buyers are thought to be suppressing prices at the moment. But they will run out of capacity eventually. What premium other investors will demand for taking on longevity risk is the question that will decide the success of this nascent market.

Cat bond market develops new collateral trends

2010-02-01T14:20:00.001-08:00

Original posted on Reuters by Sarah Hills:

After turmoil in the wake of the collapse of Lehman Brothers, the market in catastrophe bonds finally appears to be reaching a consensus on how to structure collateral, paving the way for further growth of the sector.

Lehman's failure in late 2008 threw the market into chaos, prompting a freeze in new issuance that lasted several months, because the ill-fated bank had played a counterparty role in several cat bonds.

Prospective issuers cast around for new collateral solutions that would avoid the kind of credit risk presented by Lehman, and moved towards more conservative solutions such as government-backed collateral and money market funds. But there was little meeting of minds among sponsors and investors about which solutions were best.

In the last few months, however, market approval has coalesced around two solutions: U.S. Treasury money market funds and structures based on London Interbank Offered Rates .

These two arrangements look likely to become standard for most future issues of cat bonds, increasing predictability in the market and making individual bonds easier to compare. That should draw more investor interest, analysts and investors who are currently active in the market say.

"These solutions help mitigate credit exposure to the assets in the collateral account, provide the protection sponsors and investors want, and are equally beneficial from a credit perspective," said Gary Martucci, director at Standard & Poor's Insurance Ratings.

"In addition they allow more flexibility from the structuring side. This brings the primary focus of the cat bond back onto the insurance risk - not the credit risk."

WRONG ASSUMPTION
Before Lehman's bankruptcy, many cat bonds used banks as "total return swap" (TRS) counterparties in the mistaken belief that the banks were completely safe guarantors for the bonds.

The Lehman debacle proved that assumption spectacularly wrong, and the four cat bonds that used Lehman as a TRS counterparty have either defaulted or remain vulnerable, analysts say.

Lehman showed the cat bond sector needed to resolve problems with credit risk, market-to-market risk and liquidity risk, said Rupert Flatscher, head of Munich Re's risk trading unit.

So last year, cat bond issuers cast around for structures to replace TRS, in what may be the sector's greatest burst of innovation since it was launched in the mid-1990s.

S&P noted in a recent report that only four of the 19 transactions completed in 2009 used TRS, and all four closed in the first quarter.

Among the 19 cat bonds, three main collateral solutions were used: investments in U.S. Treasury money market funds; AAA-rated government-backed assets, involving institutions such as the International Bank for Reconstruction and Development; and tri-party repurchase agreements.

Tri-party repos use a bank's portfolio of investment-grade corporate bonds to generate returns based on Libor, with independent reporting to investors on daily pricing. They were first used last July by BNP Paribas in Hannover Re's Eurus II cat bond.

"The natural cat bond market today is approximately $12 billion in size with 85 percent of outstanding deals explicitly priced against a Libor benchmark", said Rishi Naik, head of insurance-linked securities trading at BNP Paribas.

He said the tri-party repo solution was attractive partly because it targetted Libor as its underlying hurdle rate. Also, tri-party repos have tended to provide higher returns than solutions based on U.S. Treasury money market funds.

COMPLEXITY
However, some areas of the market regard tri-party repos with caution because of their complexity, which can involve greater credit risk; only three such deals were done last year.

Bill Dubinsky, director in Swiss Re's capital markets team, said tri-party repos added no value in an environment where credit risk was equal to the increased yield.

"Investors prefer a simple solution with minimal credit risk," he said.

And while the government-backed asset model was used last year, investors and sponsors believe it was partly a response to the financial crisis, and may become less popular as the crisis fades.

"These bonds benefited from a regulatory situation where you had government agencies issuing bonds or guaranteeing bonds on behalf of other organisations, but that was always going to be a short-term phenomenon," said Naik.

This means U.S. Treasury money market funds, used in eight cat bond transactions last year, may be the most common model used in coming years. They offer relatively low returns, but a minimum of risk.

Flatscher said the cat bond market was fortunate in now having a choice of several safe, robust collateral solutions.

"Now the cat bond community can concentrate on the more important aspects of the sector -- such as attempting to bring in a wider range of investors to the space in order to bring down the price of cat bonds to a more reasonable level."

Disappointing data dampen catastrophe bond deals

2010-02-01T14:19:00.000-08:00

Original posted on Reuters by Sarah Hills:

Catastrophe bond issuers must provide deeper and richer data to attract new types of investors being courted to risk potentially massive financial losses from hurricanes and earthquakes, portfolio managers and deal sponsors said on Friday.

Data accompanying offerings of cat bond and other insurance linked securities (ILS), which totaled $3.5 billion during 2009, pales in usefulness compared with data given in the wider global reinsurance market, these people said.

"There's a certain difference in how data is provided, or how information is provided, and the quantity of data that is provided for the ILS market and the traditional reinsurance market," Insa Adena, head of advanced risk intermediation for Allianz, said at an investors conference.

ILS is a relatively new and growing asset class of about $15 billion. It offers tailored bonds for natural disasters and other risks and competes with reinsurers. Returns for investors in ILS have been strong in recent years.

But managers of ILS deals and portfolio managers said the ILS sector was now restricted mainly to institutions able to analyze on their own the complex risks of financial losses from massively dispersed storms and other phenomena.

The data typical of ILS deal documents was repeatedly described by ILS professionals as insufficient for most other investors and may be keeping some potential issuers out of the ILS market.

"There's not a lot of visibility in the data quality," Glen Daraskevich, senior vice president at risk-management advisor Karen Clarke & Co, "Only companies that have been in existence for a long time and people who are very comfortable with it seem to be able to participate in the market."

Daraskevich said in an interview on the sidelines of the Insurance Linked Securities Summit that the shaky nature of some ILS-offering data may also be leading to needlessly higher prices for cat bonds.

"From an investors' standpoint, 'Since we don't see the data quality, we're just going to assume the worst'," Daraskevich said.

ILS deals with more credible data allowing investors to more confidently gauge potential losses would likely get lower prices, according to Daraskevich.

Traditional reinsurance deals were often done on a one-to-one basis that gave issuers assurance that company loss statistics and other data would not leak to competitors, he said.

"Usually you have to give everyone the same information ... and that's why, I think, sponsors (in ILS deals) would be hesitant to post all their information up on the Web," he said.

David Lalonde, a senior vice president of AIR Worldwide, a provider of forecasting models relied on by investors in gauging deal risks, said at a presentation that the leading modeling firms were not always receiving the same data for their forecasts.

Association formed to transfer longevity risk to capital markets

2010-02-01T14:17:00.000-08:00

Original posted on Reuters by Sarah Hills:

A new association has formed to transfer longevity and mortality-related risk to the capital markets in the same way that some of the world's biggest perils, such as hurricanes and earthquakes, are protected against by shifting the risk to investors via catastrophe bonds.

The Life and Longevity Markets Association (LLMA), made up of a consortium of banks, insurers and pension experts, will develop a series of standardised indices that can be used as a global benchmark for trading longevity and mortality risk.

The risk will be traded as swap structures initially, but as the market develops, longevity bonds will be created to transfer the risk, much like transactions such as cat bonds in the insurance-linked securities (ILS) market and other large trend risks like interest rates and inflation.

Traditionally, longevity was owned by pension funds and transferred in the form of buy-ins and buy-outs to pension insurers, who then underwrite price specific pension fund risk. But the LLMA want to transfer the UK's 2 trillion pounds ($3.3 trillion) pension liability assets to the capital markets to help pension schemes and insurers manage the financial pressure of increased life expectancy.

Dramatic increases in life expectancy have left private sector pension funds and annuity providers with massive exposure to longevity, and there are few options currently available to hedge this risk on any significant scale within the private sector.

In the last three years, around 19.5 billion pounds of longevity risk has moved over from the pension funds to the pension insurers, which is a small amount compared to the total assets in the UK, John Fitzpatrick, a director of the LLMA and a partner at Pension Corp, told Reuters.

"The existing transactions between (re)insurers and the capital markets are relatively small. The association wants to build capacity in the capital markets and reinsurance sector in order to handle the likely increase in demand coming forward from longevity risk," he said.

"Longevity risk is a size that it should also go out to the capital markets."

In the next 20 years, the number of retirees is expected to increase by 60 percent, which will create a large financial risk to pension funds, governments and local authorities who run the schemes, said Fitzpatrick.

The ILS sector has been targeted due to its non-correlation to the performance of the broader fixed income market, which represents credit and market risk, according to the LLMA.

"Those investors already involved in the ILS market may already own the risk of lethal epidemics and life insurance, which are the mirror image of longevity risk and a natural hedge against mortality risk," said Fitzpatrick.

The LLMA will focus on pension-related longevity and mortality, rather than life settlements, and will look to increase its scope outside the UK as the initiate develops.

"The aim is to create a standardised product that the market can understand and trade. If we accomplish that, there will be more investors and more capacity to take on the risk from the pension funds, who are looking to reduce the largest risk they have in their portfolio, which is longevity," said Fitzpatrick.

The LLMA was established by AXA , Deutsche Bank , J.P. Morgan, Legal & General , Pension Corporation, Prudential , RBS and Swiss Re .

National Drought Insurance for Malawi

2010-01-21T23:10:00.000-08:00

World Bank working paper by Joanna Syroka and Antonio Nucifora

Abstract: Malawi has experienced several catastrophic droughts over the past few decades. The impact of these shocks has been far reaching, and the resulting macroeconomic instability has been a major constraint to growth and poverty reduction in Malawi. This paper describes a weather risk management tool that has been developed to help the government manage the financial impact of drought-related national maize production shortfalls. The instrument is an index-based weather derivative contract designed to transfer the financial risk of severe and catastrophic national drought that adversely impacts the government's budget to the international risk markets. Because rainfall and maize yields are highly correlated, changes in rainfall -- its timing, cumulative amount, and distribution -- can act as an accurate proxy for maize losses. An index has been constructed using rainfall data from 23 weather stations throughout Malawi and uses daily rainfall as an input to predict maize yields and therefore production throughout the country. The index picks up the well documented historical drought events in 2005, 1995, 1994, and 1992 and a weather derivative contract based on such an index would have triggered timely cash payouts to the government in those years. This innovative risk management instrument was pioneered in 2008/2009 by the Government of Malawi, with the assistance of the World Bank, and was a first for a sovereign entity in Africa. Several piloting seasons will be necessary to understand the scope and limitations of such contracts, and their role in the government's strategy, contingency planning, and operational drought response framework.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1536982

Swiss Re Expects Cat Bond Sales to Grow 43% in 2010

2010-01-21T09:01:00.000-08:00

Original posted on Bloomberg by Oliver Suess and Carolyn Bandel

Swiss Reinsurance Co., the world’s second-largest reinsurer, expects catastrophe bond sales to increase by at least 43 percent this year as maturing notes are replaced and the market lures new investors.

“The pipeline for new cat bonds is very active and the momentum of 2009 will surely continue,” Martin Bisping, head of non-life risk transformation at the Zurich-based reinsurer, said in an interview. “We expect the market to broaden.”

Swiss Re’s outlook matches that of larger German rival Munich Re, which earlier this month said cat bond sales may climb to $5 billion in 2010 from about $3.5 billion last year. About $5 billion of notes expire this year, Swiss Re said.

Swiss Re, lead manager on just over half the 2009 issues, said the global cat bond market may almost triple over the next five years as demand for natural catastrophe coverage increases. Demand for the securities, which help cover insurers and reinsurers against claims from natural disasters such as hurricanes and earthquakes, will increase as prices become more competitive.

“We are optimistic about the growth prospects of cat bonds and expect that the market will accelerate further by the convergence of price levels between capital markets and reinsurance,” Bisping said. “It remains to be seen whether the market will surpass $5 billion by year end.”

Bond Slump

Cat bond sales slumped following the failure of Lehman Brothers Holdings Inc., which had guaranteed returns on four cat bonds. This year’s sales may challenge the record of about $7 billion in 2007, said Christian Bruns, who co-manages about $1 billion in insurance-linked investments at Credit Suisse Group AG’s Clariden Leu private banking unit.

“I’m confident that the market can reach $5 billion to $7 billion in new issuances this year,” said Bruns. “We will also see more European and Asian risks being sold to the market this year as investors seek more diversification.”

Expectations for 2010 are positive after an “exceptionally quiet” 2009 hurricane season, said Peter-Jan de Koning, senior investment manager for alternative investments at Zeist, Netherlands-based PGGM, which manages 84 billion euros ($118 billion) in pension money and invests as much as $1 billion in cat bonds.

While volumes this year will be at least as strong as 2009, increased competition from the “traditional” reinsurance market may temper cat bond issues, Fitch Ratings Ltd. said yesterday.

Windstorm Index

While cat bonds for U.S. hurricanes and earthquakes accounted for about 80 percent of last year’s total, Swiss Re expects a broader set of risks to be covered in 2010 with more European storm risks coming to the market, Bisping said. That is reflected in Perils AG, an insurance industry initiative started this year that offers aggregated European catastrophe loss data, he said.

“It’s an important step to provide a more transparent European windstorm index, which should help to stimulate the development of capital markets products,” Bisping said.

While the cat bond market may reach about $20 billion by 2014, from $14 billion at the end of last year, in line with increasing demand for natural catastrophe coverage, it could outpace industry growth, said Bisping.

“If cat bonds would double their share of total natural catastrophe reinsurance capacity, we may even see the market reach $40 billion by 2014,” he said. “Investors are willing to allocate more capital to the sector as shown by the strong oversubscription for many of last year’s cat bonds.”

The bonds currently represent about 7 percent of total nat- cat reinsurance capacity, Bisping said.

While there has only been one transaction this month, which is typically a quiet one for issuance, two or three new cat bonds may be placed during the coming weeks, said Bruns, who declined to give any details.

Swiss Re’s latest cat bond was a $150 million note issued in December through Redwood Capital XI Ltd. to help protect the reinsurer from Californian earthquakes.

Quake triggers $8m cover from CCRIF

2010-01-15T14:12:00.000-08:00

Original posted in the Royal Gazette by Alex Wright:

The earthquake that struck Haiti will trigger the country's full $8 million earthquake cover with the Caribbean Catastrophe Risk Insurance Facility (CCRIF), according to the organisation.

Haiti bought both quake and windstorm cover from CCRIF, paying $385,000 for its earthquake cover. The payment will be made after the standard 14-day wait period enforced by the CCRIF.

The organisation said it was hopeful that "the rapid payment of funds under Haiti's policy will assist the Government and people of Haiti in addressing immediate needs as they begin the recovery and rebuilding process".

Little of the damage in Haiti, which appears to have claimed tens of thousands of lives, is directly insured, meaning the impact on insurers is likely to be limited. Haiti has a population approaching nine million, while the capital, which accounts for most of the insured property, has a population nearing two million.

California-based risk modeller Risk Management Solutions said that annual property and casualty (P&C) insurance premium in Haiti falls just short of $20m, making it one of the smallest insurance markets in the hemisphere. That figure amounts to just 0.29 percent of Haiti's 2008 GDP of $7 billion. Structures that were damaged or destroyed in Tuesday's 7.0 magnitude quake include the presidential palace, World Bank offices, the local United Nations headquarters, as well as several schools, hospitals and hotels.

"Haiti is the poorest country in the Western Hemisphere and poor countries tend to purchase very little property insurance coverage," said Dr. Robert Hartwig, president and economist for the Insurance Information Institute.

"The fact that there is very little information about Haiti's private insurance market suggests that the market is very small-likely not more than a few tens of millions of dollars. Consequently, private insurer losses from the 7.0 temblor on Tuesday, January 12, will be modest and will not have a material impact on global insurance and reinsurance markets."

Beyond earthquakes, Haiti's insurance markets face a litany of challenges including frequent hurricanes, severe floods, landslides and mudslides, poor public safety infrastructure and the fact that the country has a history of political and civil unrest, said Mr. Hartwig. He added that some multinational firms with facilities in Haiti may be insured for losses under blank policies that respond to losses wherever in the world they occur.

A December 2009 report by Axco Insurance Information Services on Haiti's non-life (property/casualty) market, said: "Some 90 percent or more of Haiti's insured risks are situated in Port-au-Prince, but no information is available about aggregate sums insured."

In the absence of official data, Axco estimated the total non-life premium income written in Haiti at $19 million in 2008, with the non-life category consisting primarily of P&C policies for auto, homeowners and commercial insurance.

Hartford plans $100 million catastrophe bond

2010-01-14T12:22:00.000-08:00

Original posted in Business Insurance:

Hartford Financial Services Group Inc. plans to place a $100 million catastrophe bond to cover a portion of its U.S. hurricane exposures, a market source confirmed Wednesday.

The bond, Foundation Re III Ltd., is being marketed to investors and is expected to close at the end of January, the source said.

If successful, it will be the first cat bond transaction during 2010.

A dramatic drop in cat bond pricing and strong investor demand are creating favorable conditions for sponsors to issue bonds, and experts have predicted strong activity levels for the sector this year.

Earlier this week, Aon Benfield Securities said cat bond pricing declined up to 36% for peak-zone perils in the United States during the fourth quarter of 2009.

The Hartford, Conn.-based insurer has issued two other bonds through its Cayman Islands-based special-purpose vehicle, Foundation Re Ltd.

Longevity offers opportunities

2010-01-07T14:18:00.000-08:00

Original posted in the Financial Times by Paul J. Davies:

The second world war, dockyard working conditions of the 1950s and futurology about potential medical uses of stem cells might all sound like good topics for a bit of escapist holiday reading. But for a growing number of bankers, investors and reinsurance professionals, such subjects are becoming part of their working lives.

The reason? They all offer potential insights for estimating coming trends in longevity, which govern one of the most significant and least understood liabilities for pension and annuity funds. This year is expected to see strong growth in the volume of trades to offload longevity risks after 2009 saw Goldman Sachs complete the first deals done for corporate pension schemes directly.

A market for transferring longevity risks – the risk that people live much longer than actuaries expect – has long been talked about, but failed to materialise in any substantial form until the past 18 months, when almost $10bn worth of trades were done.

Guy Coughlan, a senior banker to the insurance industry at JPMorgan, says the focus has long been on matching the interests of life insurers and pension funds, but that longevity cannot be tackled without the capital markets.

“If you look at the amount of longevity risk in just the UK, there’s not enough insurance capacity globally to take it on,” he says. “If there were a rush for the exits [by pension schemes], the market would not be able to bear it.”

This is why there is a need for risk transfer solutions through the capital markets to financial investors, he says.

Strange as it may sound, the financial market turmoil of the past two years may have provided just the catalyst the market needed.

There are three main reasons for this. First, longevity risk was long a secondary concern for the large bulk-annuity providers, which priced business more in relation to the returns available on the assets they could invest in.

Second, while the stock market recovery has improved the asset position of many schemes, the still high spreads on corporate bonds mean liabilities have grown dramatically, adding impetus to the need to manage all elements of pension liabilities better.

Third, investment banks are desperately hunting for new, high-margin businesses to replace the structured products and credit trading of the boom years.

Niklaus Hilti, head of insurance-linked securities at Credit Suisse Asset Management, thinks there will be a rush into the market this year.

“Many investment banks have a lot of brain capacity and they want to explore new markets,” he says. “There is high demand from pension funds and insurers to offload this risk.”

One longevity expert at a European reinsurer not yet involved in the market says the handful of investment banks already involved are looking to package up longevity risks and find ways to limit its duration and make it more tradeable. “They want to do this on an industrial scale,” he says. “But you have to ask the question: will it be the next subprime?”

Tom Pearce, executive director at Rothesay Life, the specialist pensions unit of Goldman Sachs, reckons such industrial packaging is a long way off. “People always have the dream of securitisation for this type of risk. The ultimate goal will be that as an exit route,” he says.

The pricing of longevity risk has improved since the market turmoil disrupted the stable returns available to traditional insurers and asset gatherers, according to bankers and investors. But the same turmoil has also made traditional assets, such as corporate bonds, more attractive as their returns have risen.

Plenty of specialist investors and reinsurers on the sidelines think that longevity risk is still underpriced. The reinsurers, which have been the biggest buyers of longevity risk in recent swap deals, may be relying on diversity of risk in their books to lower their capital requirements, enabling them to offer cheaper deals. Or, as some suspect, they may be pricing the risk attractively in order to build a market presence.

According to Mr Hilti, however, it is less the price than the long-term and illiquid nature of the risk that is the biggest obstacle to getting the capital markets fully involved.

Some banks are putting their efforts into index-type products or other standardised deals, such as JPMorgan’s Life Index. Mr Coughlan says, however, that most of the deals his bank has done have been bespoke trades tailored for specific client needs.

Most deals have involved very specific groups of people. For example the Babcock International deal, the first pension scheme longevity trade, involved former dock workers from two sites – one in the north-east of England and one in Plymouth, according to those involved.

The longevity profile of such a specific group will be nothing like the broad population of the UK, let alone further afield, making the risk difficult to hedge versus something like a broad Life Index.

Mr Hilti adds that another big challenge for a market that is still mainly focused on the UK is a lack of diversity of risks.

“This is a highly complex risk and it can have very large variations between different market segments,” he says. “For example, certain age groups in the UK are living much longer than the same group in other parts of the Continent. One theory for this is about the different living conditions they endured during the second world war, differences in diet or stress.”

One thing most agree on is that larger deals from very big pension schemes are better because there are more data on mortality and more diversity of lifestyles. However, the law of large numbers was also held up as a mark of safety for the securitisation of residential mortgages.

First snowfall trade cleared on CME

2010-01-06T04:19:00.000-08:00

Posted on Risk.net by Pauline McCallion:

Choice Environmental, a portfolio company of OTC Global Holdings (OTCGH), has brokered the first CME-cleared snowfall hedging risk instrument – a snowfall binary option contract for Detroit.

The contract was a seasonal maximum binary option for January to March of 2010 and was executed on the exchange on December 22. It was brokered by Choice Environmental on behalf of a reinsurance company and a Midwest supplier whose business is tied to snowfall levels.

“The snowfall binary option contract is an innovative hedging tool that brings new end-user participants to the market and has the potential to add significant liquidity to weather-related derivatives contracts,” said Clinton Kripki, director of environmental markets for Choice Environmental.

Choice Environmental, which has offices in Houston and New York City, offers OTCGH clients brokering services and expertise in structured renewable products, weather options and derivatives.

Swiss Re closes Redwood Capital XI Ltd. catastrophe bond

2010-01-05T06:19:00.001-08:00

Zurich, 5 January 2010 – Swiss Re has obtained USD 150 million protection for California earthquake risk through the Redwood Capital XI Ltd. catastrophe bond programme.

Swiss Re has entered into a transaction with Redwood Capital XI Ltd. (“Redwood XI”) to receive up to USD 150 million of payments in the event of a California earthquake in the covered area that meets specific trigger criteria. The transaction covers a one-year risk period ending on 31 December 2010. Redwood XI has in turn hedged this risk by issuing catastrophe bonds into the capital markets. Redwood XI is a special purpose vehicle with a flexible programme structure that will allow subsequent issuances of notes.

Swiss Re has a strong track record of securitising California earthquake risk, obtaining over USD 2 billion of protection through prior Redwood programmes since 2001.

Swiss Re’s Chief Underwriting Officer, Brian Gray, commented: “Swiss Re has developed a leading market position as a sponsor, underwriter and innovation leader. Our ILS expertise is part of our core offering to clients and a fundamental piece of our own hedging strategy.”

The Redwood XI offering consists of one series of notes, rated “B1” by Moody’s.

Swiss Re Capital Markets acted as sole manager and bookrunner on the note issuance. With the closure of Redwood XI, Swiss Re Capital Markets solidified its standing as the number one lead manager for
ILS transactions in 2009. The collateral for this issuance of Redwood XI notes consists of treasury money market funds. Risk modelling and analysis was performed by EQECAT, Inc.

Brian Gray concluded: ”The ILS market gained considerable momentum in 2009. More conservative collateral structures, price convergence with the reinsurance market, and the underlying value of diversification should further accelerate the ILS market in 2010.”

The Redwood XI notes were sold in a private placement pursuant to Rule 144A of the U.S. Securities Act of 1933, as amended, (the “Securities Act”) and have not been registered under the Securities Act or any state securities laws; they may not be offered or sold in the United States except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws.

Cat bond sector issuance in 2009 eclipses 2008 year-end total

2010-01-04T09:58:00.000-08:00

Original posted on Reuters by Sarah Hills:

The catastrophe bond sector ended 2009 with nearly $3.4 billion of new issuance through 18 transactions, which marked a 25 percent increase over 2008 as the market recovered from its post-Lehman paralysis.

The total is still a long way off the record level of $7 billion in issuance in 2007 through 27 cat bonds -- in which insurers transfer risks associated with natural disasters to capital markets investors.

However, the increase in 2008 levels marks an improvement in cat bond issuance conditions and a stabilisation in the financial markets.

Paul Schultz, President of Aon Benfield Securities in Chicago, told Reuters market appetite for alternative sources of capacity remained strong, and pricing became more in line with the traditional market.

"Volumes in terms of frequency and size of transactions have gone back to the "normal" levels of activity we saw prior to the challenges that arose following Lehman Brothers collapse in September 2008," he said.

The financial crisis meant no bonds were issued for six months after the Lehman's Brothers collapse in September 2008, in which the bank played a counterparty role in several cat bonds, and resulted in a year end figure of $2.7 billion through 13 cat bonds.

After the six-month impasse following Lehman's collapse, the market began a resurgence in February 2009, with nine transactions successfully completed through June 30, 2009. The first deal that entered the market during this period was Scor's $200 million Atlas V Capital Limited.

The final cat bond of 2009 was Zurich's Lakeside Re II, which closed at $225 million. The fourth quarter of 2009 saw seven bonds issued, five of which were upsized following strong investor demand and improved cat bond pricing in the sector, and accounted for approximately $1.4 billion in issuance.

Thomson Reuters figures for the total outstanding issuance of Natural Catastrophe Bonds -- equal to the amount of nat cat risk transferred to the capital market via bonds -- came in at $12.75 billion for 2009, compared to $13 billion in 2008.

Guy Carpenter said in its Global Reinsurance Renewals Report that pricing and capacity conditions in the cat bond market were significantly different between the first and second halves of 2009, stating that cat bond pricing was up by nearly 50 percent compared to early 2008.

However, in the third and fourth quarters, cat bond pricing declined 25 percent to 40 percent compared to 2008 and is now tracking with 2007 levels.

MATURING MARKET

"Risk placed in the fourth quarter, when compared to comparable risk placed in the first two quarters, has seen pricing come in as much as 300 basis points. That movement should encourage a number of sponsors to come to market in the first half of 2010," Michael Halsband, a vice president on the financial institution structured finance desk at Goldman Sachs, told Reuters.

"The tightening of terms and conditions and continuing discipline in the structuring of the transactions will allow this market to continue to stabilise as it matures further," he said.

Halsband said he expects to see two particular points in time in 2010 of considerable activity. January and February, and May and June will be busy months as bonds mature and new capital is raised by dedicated cat funds and other investors, he said.

Another trend, which has contributed to the improvement in the cat bond sector, is in relation to the big purchasers of reinsurance capacity.

"The primary companies are integrating their cat bond purchases into their overall capacity purchase programme," said Chi Hum, global head of distribution, GC Securities, Guy Carpenter.

"The ability of these users to adapt their structures and the ability of the dealers to integrate and optimise this new source of capacity into an overall purchase programme will enhance the insurance-linked securities sector and make it a core part of a company's capacity purchase programme."

Centurion launches first ever macro/micro longevity fund

2010-01-03T19:00:00.000-08:00

Centurion Fund Managers has obtained regulatory approval from the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg for its fourth open-ended longevity fund - which is the first in the market to combine macro and micro longevity. The professional investor fund - which is called the Centurion Longevity Fund - targets an annual return of 6-9% with low volatility and minimal correlation to the stock markets.

Read the full article

Cat bond activity jumps in '09 as issuers slash prices

2010-01-03T11:10:00.000-08:00

Original posted on Business Insurance by Colleen McCarthy:

A strong fourth quarter pushed 2009 catastrophe bond activity to about $3.5 billion, which experts say signals a healthy comeback for the sector.

A dramatic drop in cat bond pricing combined with strong investor demand boosted issuance, experts say.

“There is a lot of optimism. We've seen a very good fourth quarter with virtually all of the deals upsized from their original target,” said Markus Schmutz, of insurance-linked securities at Swiss Reinsurance Co.'s Capital Markets division in New York.

A total of 18 cat bond transactions in 2009 demonstrated a strong recovery for a market that had stalled during the financial crisis, many experts say. Issuance volume stood at roughly $3.5 billion at year-end—exceeding the $2.7 billion issued in 2008 but off sharply from the record $7 billion issued in 2007, according to data from New York-based reinsurance broker Guy Carpenter & Co. L.L.C. and investment banking arm GC Securities Ltd.

Seven catastrophe bonds totaling about $1.5 billion were issued in the fourth quarter of 2009 vs. zero bonds in the same period in 2008 as investors shied away from the market.

Fourth-quarter 2009 also produced some of the most favorable conditions for sponsors this year, with pricing for insurers to issue cat bonds declining as much as 25% compared with the start of the year, said Swiss Re's Mr. Schmutz. Cat bond spreads that determine the price for sponsors tightened considerably as investors were willing to accept lower returns, he said.

Also driving down costs for insurers was strong investor demand. Compared with other asset classes, “investors are very pleased with the way cat bonds have performed this year, and we're seeing a lot of new money come into the sector,” said Al Selius, head of New York operations for Securis Investment Partners L.L.P., a London-based insurance-linked securities investment firm.

In addition, some $660 million in maturing bonds was reinvested in the sector during the fourth quarter, said Chi Hum, global head of distribution at GC Securities Ltd. in New York. “Investors are basically flush with cash and they need to put that money back to work,” he said. GC Securities estimates another $2 billion in maturing bonds will be redeployed in the first half of 2010.

The influx of additional capacity has resulted in generally larger deals at better prices, observers say. One of the largest deals of 2009, a $500 million cat bond placed by Travelers Indemnity Co., originally was marketed to investors with a target total of $250 million. When it closed last month, it doubled in size due to strong investor demand. The bond, Longpoint Re II Ltd., provides the Hartford, Conn.-based insurer with multiyear reinsurance protection against U.S. hurricane risks.

Two other fourth-quarter bonds were upsized, including Swiss-based Flagstone Reinsurance Holdings Ltd.'s bond, Montana Re Ltd., from $120 million to $175 million. The bond covers U.S. hurricane and earthquake risks for three years.

In addition, Zurich-based Swiss Re's bond, Successor X Ltd., increased from $60 million to $150 million by the time it closed last month. The bond covers losses from California earthquakes and U.S. Atlantic hurricanes.

Insurers and reinsurers covering peak perils, including U.S. hurricane, U.S. earthquake and European windstorm risks, dominated the 2009 deals. While experts expect demand for what is known as the “big three” perils to drive market growth, other deals in 2009 sought protection from losses related to Japanese earthquakes, Mexican catastrophes and California earthquakes.

Observers say several trends emerged in 2009 that point to a shift in the market. For example, in previous offerings, reinsurers largely dominated cat bond issuance, but in 2009, primary insurers backed about 60% of the bonds.

“The primary companies are looking towards the cat bond market to be a core part of their capacity source and they are using the capital market as a way to diversify and balance out their traditional reinsurance,” Mr. Hum said. For insurers “that have to hedge an inbound book of business, having an alternative source of capacity is huge; it's strategic,” he said.

Meanwhile, reinsurers are being more “opportunistic,” Mr. Hum said. “We didn't see reinsurers start to participate in the market in 2009 until the pricing really became favorable.”

In addition, Mr. Hum said many sponsors looking to integrate cat bonds into their overall program have sought additional flexibility. For example, Travelers' bond is structured in two tranches and features a “dual maturity” issuance. The $250 million Class A notes provide three years of protection against certain U.S. hurricanes and $250 million Class B notes provide similar protection for a four-year period. “It gives them more flexibility and allows them to better manage through the pricing cycle,” Mr. Hum said.

GC Securities acted as a joint underwriter on the deal, along with Deutsche Bank Securities and Swiss Re Capital Markets.

As for 2010, observers say they are optimistic and the pipeline for potential deals is strong.

“Now that spreads have returned to precrash levels, we would envision volumes returning to precrash levels,” said Peter Nakada, Hackensack, N.J.-based managing director for Newark, Calif.-based modeling firm Risk Management Solutions Inc.

Mr. Nakada estimated 2010 volume could be $6 billion to $8 billion.

Natural disaster costs fell in 2009 - Aon Benfield

2009-12-29T07:02:00.000-08:00

Original posted on Reuters by Sarah Hills:

Insured losses from natural catastrophes globally fell to their lowest level for three years in 2009 because of atypical weather conditions, according to reinsurance broker Aon Benfield.

It calculated that insured losses totalled $20 billion this year, with a total economic loss of $58 billion.

There were 222 separate natural catastrophes in 2009, compared to 213 in 2008 and 217 in 2007.

This year was the fifth warmest on record, Aon Benfield noted; many scientists believe rising temperatures will produce more violent weather patterns in the long term.

But El Nino, the Pacific warm-water pattern which tends to limit the formation of tropical storms and hurricanes in the Atlantic, helped to suppress storm activity after it emerged in June this year, the broker said. El Nino occurs every two to five years and usually lasts about a year.

Aon Benfield said 2009 was the fourth consecutive year in which the frequency of tropical storm systems across the world's ocean basins was low. There were only 33 hurricanes, typhoons and cyclones, 19 major storms and 12 landfalling hurricanes, typhoons and cyclones.

In an average year, around 49 hurricanes, typhoons and cyclones develop, 24 of which strengthen to or above Category 3 status. On average, around 17 hurricanes, typhoons and cyclones make landfall across the world.

This year saw the lowest number of "named" storms -- those given names by authorities, usually because of their large size -- in the last 25 years. In the Atlantic, there were nine named storms in 2009, compared to a 25-year average of 13, and no hurricanes made landfall in the United States.

Windstorm Klaus, which mostly affected France, Spain and Italy, was the most costly event this year, causing insured losses of $3.3 billion and economic losses of $6 billion.

Typhoon Ketsana, which struck the Philippines and Vietnam in September, damaged more than seven million structures, but casued a relatively small insured loss of $260 million.

No single event caused insured losses above $5 billion this year. In 2008, Hurricane Ike caused more than $12.5 billion of insured losses, and in 2007 Windstorm Kyrill cost insurers over $6.2 billion. Hurricane Katrina in 2005 remains the costliest insurance event in history, at $45.5 billion.

A report by reinsurance broker Guy Carpenter this week also found that 2009 caused the lowest insured losses from natural disasters in three years, at $24 billion -- a plunge from $52.5 billion in 2008.

To see the full Aon Benfield report, click here.

Munich Re: '09 catastrophe costs dropped 75 pct

2009-12-29T06:57:00.000-08:00

Original posted on Reuters by Maria Sheahan:

The total costs associated with natural catastrophes in 2009 will be about $50 billion, a mere quarter of the year-earlier figure, according to estimates from Munich Re published on Tuesday.

The world's biggest reinsurer by revenues said in an excerpt of its annual report on natural catastrophes that while overall losses were well below the 10-year average of $115 billion, the trend toward more weather-related catastrophes was continuing.

Insured losses, those losses which insurers and reinsurers will have to cover, are estimated to have more than halved from 2008 to $22 billion.

In terms of insured losses, winter storm Klaus, which hit northern Spain and southwest France in January, was the most expensive individual event in 2009, with insured losses of $3 billion and an overall cost of $5.1 billion.

In terms of human life, Asia continued to be the continent affected by the worst human catastrophes. A Sumatra earthquake claimed almost 1,200 lives, and more than 1,700 people died in storms in countries such as Vietnam and Taiwan in 2009.

Munich Re said that 2009 continued the long-term trend of increasingly frequent weather extremes and ensuing natural catastrophes, which will result in greater and greater losses. Since 1980, weather-related natural catastrophes have cost a total of about $1.6 trillion, it said.

"Climate change probably already accounts for a significant share. In the light of these facts, it is very disappointing that no breakthrough was achieved at the Copenhagen climate summit in December 2009," Munich Re Board member Torsten Jeworrek said in a statement.

2009 Catastrophe Update: Global Insured Losses in 2009

2009-12-28T06:25:00.000-08:00

Original posted om GCCapital.com by:

2009 has seen an impressive recovery from last year’s financial crisis and the uncertainty caused by losses from Hurricane Gustav and Hurricane Ike. This recovery has been driven by the easing of financial markets and low catastrophe activity. A very quiet hurricane season, coupled with relatively low losses for other weather-related events, meant insured losses reached USD24 billion in 2009(1), the lowest figure since 2006 and a significant fall from USD52.5 billion(2) in 2008.

Weather-related events continued to be the largest source of losses in 2009 at USD21 billion, while man-made disasters triggered insured losses of USD3 billion. Total losses (both insured and uninsured) reached USD52 billion in 2009, while some 12,000 people lost their lives to natural catastrophes and man-made disasters.

Figure 1 shows Swiss Re’s estimate of global insured losses since 1970 with the provisional amount for 2009 at constant prices. The 10-year moving average of insured losses retreated slightly, falling from USD38.1 billion in 2008 to USD36.2 billion in 2009.

Figure 1: World Catastrophe Losses (Source: Swiss Re, Guy Carpenter)

Five events incurred insured losses of more than USD1 billion in 2009(3) . Three were related to severe weather and tornadoes in the United States, while Windstorm Klaus and severe summer hailstorms caused significant losses in Europe. In contrast to the United States, Europe suffered above-average insured losses in 2009.

Windstorm Klaus hit France and Spain with hurricane-force winds on January 23 and 24, leaving a trail of destruction and disruption as roofs were ripped off houses and trees were downed. Wind gusts peaked at 195 kmph (120 mph), killing 25 people and cutting power to at least 1.7 million households. The storm was the most powerful to hit France since Windstorm Martin in 1999. Windstorm Klaus was the most costly event of 2009 after it triggered insured losses of around USD3.5 billion(3).

Elsewhere in Europe, severe hailstorms hit Switzerland, Austria, Poland and the Czech Republic on July 23, causing a total insured loss of USD1.25 billion(3). The hailstorms, accompanied by powerful winds, left a trail of destruction in central and eastern Europe. Switzerland was particularly badly hit after tens of thousands of buildings and vehicles were damaged by hailstones the size of golf balls. A Guy Carpenter report on the storms in Switzerland said the event is expected to have a substantial influence on the Swiss 2010 reinsurance renewal process after insurers paid out claims totalling more than CHF733 million (USD725 million)(4).

The three other events to trigger losses in excess of USD1 billion all occurred in the United States after severe weather and tornadoes hit southern and Midwestern regions of the country in February, April and June. The February event triggered the second biggest loss of 2009 with insurance claims totalling around USD1.35 billion(5). Meanwhile, the events in April and June caused insured losses of USD1.13 billion(6) and USD1.05 billion(7), respectively.

(1) Swiss Re Press Release -November 30, 2009
(2) Swiss Re’s Natural catastrophes and man-made disasters in 2008
(3) Swiss Re Press Release -November 30, 2009
(4) http://www.guycarp.com/portalapp/publicsite/catdocument.pdf?instratreportid=1883
(5) ISO PCS Catastrophe Bulletin Serial No. 63
(6) ISO PCS Catastrophe Bulletin Serial No. 68
(7) ISO PCS Catastrophe Bulletin Serial No. 78

Munich Re provides capital-markets solution for Zurich Financial – Lakeside catastrophe bond renewed

2009-12-28T06:22:00.000-08:00

Munich Re has assisted Zurich Financial Services Group in a US$ 225m catastrophe bond transaction that transfers the risk of severe earthquakes in California to the capital markets. Munich Re acted as joint lead structuring agent in the transaction and helped placing the bond with institutional investors in the EU and Switzerland via its subsidiary Munich Re Capital Markets GmbH.

The bond with a 3-year period pays 7.75% interest plus the yield on the underlying money market funds. The bond, issued by Cayman-Islands registered Lakeside Re II Ltd., provides coverage for the Zurich Group against severe earthquake losses in California up to a maximum of US$ 225m. Replacing the expiring Lakeside Re Ltd. transaction issued in December 2006, the issuance was oversubscribed.

"We are pleased to have again been able to assist our client Zurich Financial Services Group with a capital markets transaction. Munich Re offers its clients the full spectrum of risk transfer solutions. Catastrophe bond spreads recently returned to normal so that the capital markets again constitute a good complementary risk carrier for peak risks like California earthquake", said Thomas Blunck, Munich Re Board member responsible for alternative risk transfer. "The transaction shows that investor confidence is returning."

Zurich announces completion of Lakeside Re II Ltd. catastrophe bond.

2009-12-28T06:21:00.000-08:00

Zurich, December 28, 2009 – Zurich Financial Services Group (Zurich) today announced that it has obtained, through its subsidiaries, Zurich American Insurance Company and Zurich Insurance Company Ltd, a 3-year USD 225 million catastrophe excess of loss reinsurance protection from Lakeside Re II Ltd. (Lakeside II) to cover the risk of earthquakes in California. This reinsurance transaction is a replacement of the expiring 2006 Lakeside Re Ltd. transaction.

Zurich has entered into a reinsurance transaction with Lakeside II, a special purpose reinsurance company domiciled in the Cayman Islands, to receive up to USD 225 million in payment of losses in the event of one or more California earthquakes during the 3-year period. Lakeside II, in turn, has issued to the capital markets principal at-risk variable rate notes linked to this risk. The catastrophe bond has a floating coupon consisting of a fixed 7.75% plus a variable investment yield received by Lakeside II on the underlying assets. The offering was oversubscribed.

Travelers announces completion of Longpoint Re II catastrophe bond

2009-12-22T05:24:00.000-08:00

NEW YORK, Dec 21, 2009 (BUSINESS WIRE) — The Travelers Companies, Inc. today announced that it has entered into two reinsurance agreements with Longpoint Re II Ltd. (”Longpoint Re II”), a newly formed Cayman Islands insurance company, each providing up to $250 million of reinsurance from losses resulting from certain hurricane events in the northeastern United States. The reinsurance agreements, entered into on December 18, 2009, provide protection for covered events occurring before or on December 18, 2012 and December 18, 2013, respectively. In connection with entering into the reinsurance agreements, Longpoint Re II successfully completed a $500 million catastrophe bond offering comprised of $250 million of Series 2009-1 Class A Principal At-Risk Variable Rate Notes due December 24, 2012 and $250 million of Series 2009-1 Class B Principal At-Risk Variable Rate Notes due December 24, 2013.

The catastrophe bond program with Longpoint Re II will replace Travelers’ existing catastrophe bond program with Longpoint Re Ltd., which will expire in May 2010. The reinsurance purchased from Longpoint Re II is intended to work in conjunction with Travelers’ traditional reinsurance to provide $1 billion of protection for Northeast hurricane events in excess of $2.25 billion of losses.

Amounts payable under the two new reinsurance agreements with Longpoint Re II will be based on an index created by applying predetermined percentages to insured industry losses in each state in the covered area as reported by Property Claim Services (”PCS”) a division of Insurance Services Office, Inc., owned by Verisk Analytics, Inc. The calculation of index losses is designed to approximate Travelers’ actual losses from any covered event. The amount of actual losses and index losses from any covered event may differ; however, in no event can Travelers recover more than its actual losses. The principal amount of each catastrophe bond will be reduced by any amounts paid to Travelers under the respective reinsurance agreement.

In the event of a covered loss, Travelers will be entitled to recover amounts under the reinsurance agreements if the index losses for a single occurrence reach an initial attachment amount of $2.25 billion. The full $250 million coverage of each agreement is available on a proportional basis until index losses reach an initial exhaustion amount of $2.85 billion. The attachment and exhaustion amounts will be reset annually to maintain modeled probabilities of attachment and expected loss on the catastrophe bonds equal to the initial modeled probabilities of attachment and expected loss.

Goldman retreats from life settlements

2009-12-21T05:03:00.000-08:00

Original posted on Reuters by Matthew Goldstein:

Goldman Sachs is quietly backing away from life settlements --- the business of buying life insurance policies from aging Americans in the hopes of collecting on the death benefit.

The Wall Street investment bank is ending its involvement with a "mortality index" it launched in December 2007 with high expectations. A Goldman spokesman confirmed the decision.

Goldman's QXX index tracks the life expectancy of a group of people aged 65 and older who have sold their life insurance policies to an investment pool that's managed by another firm, AVS Underwriting LLC.

The Wall Street company once had big plans to sell derivatives pegged to the index to investors seeking exposure to the estimated $15 billion life settlements market. Goldman also saw the derivatives as a potential hedge for any institutional investor buying a security or note backed by another pool of life settlements.

But the market for Goldman's index-based life settlement derivatives appears to be a casualty of the worst financial crisis since the Great Depression, said executives with several life settlements firms, who didn't want to be identified.

Goldman and other Wall Street investment banks began moving into life settlements in 2006. The banks viewed the market as a potential profit center, given the advancing age of the baby boomer population and the need for some of them to supplement their retirement incomes.

Since then, the market for exotic securities of all stripes has withered and Wall Street is struggling to revive interest in even the most mundane type of securitized products -- bonds backed by a pool of loans, mortgages or credit card debt.

The market for bonds backed by life settlements -- so-called "death bonds" -- has been even slower to pick up.

Goldman spokesman Michael DuVally confirmed that Goldman recently decided to end its involvement with the life settlements index. "It never really did much of a commercial business," he said.

But executives in the life settlements business said Goldman may also be throwing in the towel on its fledgling index because the firm is wary of the "headline risk" associated with these speculative investments. The executives did not want to be identified because some of them do business with Goldman.

Critics argue that life settlements are nothing more than an opportunity for a speculator to make a wager that a policy seller will die sooner rather than later. Investors profit by buying policies at a fraction of their face value and collecting on the death benefit when the person who sells the policy dies.

In September, the House Financial Services Committee held a hearing on Wall Street's involvement in the life settlement market and asked Goldman Chief Executive Lloyd Blankfein or one of his "designees" to testify. The firm sent Steven Strongin, a managing director, to testify. He told the panel that life settlements represented a "very small percentage of our overall business."

Strongin also testified the company had never been involved in a life settlement securitization and had "no plans to execute one."

DuVally declined to comment on the future of the firm's two other life settlements businesses, Longmore Capital and Longmore Credit. "We don't comment on our business strategies," he said.

The Longmore subsidiaries are in the business of acquiring life settlements or providing financing for those transactions. Goldman formed the businesses some three years ago after deciding against buying an existing San Diego-based firm called Life Settlement Solutions.

Centurion launches first ever macro/micro longevity fund

2009-12-21T05:00:00.001-08:00

Original posted on Reuters by Sarah Hills:

Centurion Fund Managers, asset management firm, will launch its first macro and micro longevity fund in Luxembourg.

The Centurion Longevity Fund will be the companies’ fourth open-ended longevity fund and will target an annual return of six – nine percent with low volatility and minimal correlation to the stock markets.

Centurion said investing in both macro and micro longevity products provides investors with more diversification and lower volatility and risk when compared to the more traditional micro longevity funds.

The Fund is structured as a Luxembourg registered SICAV and will now be marketed to European wealth managers, family offices and institutions seeking to invest in EU regulated and authorised products.

An informal target of $100 million has been set for the Fund.

David Rawson-Mackenzie, managing director of Centurion Fund Managers, said: “We realised that it would take some time to go through the rigorous due diligence process required by the Luxembourg authorities, particularly as our fund was unique in combining macro and micro longevity, but we now have a European compliant product with all of the transparency and reporting rigour that a Luxembourg SICAV dictates.”

Swiss Re sees accelerated ILS deal pipeline in 2010

2009-12-21T04:51:00.000-08:00

Original posted on Reuters by Sarah Hills:

Conservative collateral structures and further price convergence should accelerate the insurance-linked securities (ILS) deal pipeline in 2010 as market conditions improve according to Swiss Re.

The world's second biggest reinsurer predicted that 2009 will end as the third strongest year since the ILS sector was established, and new issuance level of $2.7 billion will bring outstanding bonds to $14.6 billion.

In addition, the anticipated $3.5 billion of issuances that has yet to close -- including Zurich American Insurance's Lakeside Re II, Travelers Indemnity Longpoint Re II, and Swiss Re's Redwood XI -- will offset $3.7 billion of maturities.

Longpoint Re II has been priced at $500 million, which will take the issuance level above $3 billion.

Swiss Re said ILS spreads have been narrowing by around 20-25 percent since June as new capital flowed into the sector - while Industry Loss Warranties (ILW) for US peak perils dropped 25-40 percent drop since early 2009.

But ILS is still priced at a higher margin than traditional reinsurance.

Catastrophe bonds, in which insurers transfer risks associated with natural disasters to capital markets investors, are fully collateralised transactions. Since the default of Lehman brothers, which played a counterparty role in several cat bonds and highlighted the potential weaknesses of TRS collateral solutions, recent new structures have looked to remove the credit risk from the deal.

An additional premium can be charged to take into account the collateralised nature of the transaction.

The TRS P&C Reinsurance Index shows a market weighted unit of Reinsurance currently has approx 50 basis points of credit risk embedded in it, however this was much higher earlier in the year.

Martin Bisping, head of non-life risk transformation at Swiss Re, said despite this ILS continues to be priced at higher margins, but current spreads are converging back to 2007 levels and he expects further tightening in the future.

Reinsurers increased participation in the ILS space from five percent to 14 percent since 2007, which Bisping said indicates further room for spread convergence between ILS and traditional markets. Since 2007, there have been at least 25 new investors that have entered the space.

Dedicated fund participation in the market increased from 46 percent in 2007 to 54 percent this year, while hedge funds, banks and money manager involvement reduced from 46 percent in 2007 to 29 percent in 2009. Insurer input remained flat at 3 percent.

Bisping said the new investor interest stems from the endurance of cat bonds throughout the financial crisis.

"They proved to be a diversifying asset with superior returns, and despite the impact of Hurricane Ivan in 2004 and the default of Lehman Brothers in 2008, the market recovered
quickly and has never made a negative return for investors."

The Swiss Re Cat Bond Total Return Index - now available at the Reuters ILS Communities site - is up 25 percent since June 2007 and 89 percent since 2002.

Bisping added that secondary market trading was strong when the liquidity of other asset classes dried up. Swiss Re traded $2.25 billion on the secondary market in 2008, he said. For 2009 the number is just over $700 million.

Investors demand extreme risk protection

2009-12-20T14:35:00.000-08:00

Investors demand extreme risk protection

Posted in the Financial Times by Sophia Grene:

Risk management theoreticians have long recognised that extreme market events are not vanishingly rare and that when the going gets tough, the similarity between returns from different asset classes goes up. The tools for incorporating an understanding of these facts into risk management have existed for some time.

Despite this, a lot of asset managers and investors failed to spot the risks they were running in the days leading up to the credit crunch and the ensuing market turmoil. Failure to understand how to use risk management tools, a reluctance to incorporate disaster scenarios into one’s world view and the inadequacy of the tools commercially available seem to have lulled investors into a false sense of security.

“It’s a function of expert risk management to know how to use the risk tools,” says Ron Pananek, head of strategy at RiskMetrics, a provider of risk management services. “A lot of users of risk management tools – I won’t say risk managers – didn’t understand how to use the breadth and depth of analysis available to them.”

Recognising the existence of extreme risk but then ignoring it is not necessarily stupid in all circumstances, according to Michael Burley, head of risk at London-based consultancy Independent Risk Monitoring .

“One could argue that almost everyone on the face of the planet is currently aware that extreme risks exist and the impact they can have. While many will have been hurt in recent years, mankind is strong enough to pick itself up, brush itself down and plough on,” he says. “So yes, the world is aware of extreme risks but unlikely to know when that next meteor is going to strike, and even less likely to sit in a bunker just in case.”

Lisa Goldberg, vice-president of MSCI Barra’s credit research group, adds: “We have been aware for ages of the multi-faceted nature of risk”. Barra’s risk modelling system is about to be upgraded with the addition of BXR, an extreme risk module.

While it may not be news that extreme risks exist, this will be the first time Barra has offered a systematic way to model portfolios taking their existence into account. The new product has been in development for several years.

BXR attempts to answer the question “what’s it really going to be like in turbulent times?” by using data showing how markets behaved historically during periods of turmoil, says Ms Goldberg. “We throw away the calm days, stand in the middle of the storm and ask ‘on average, how many houses blow down?’”.

Barra does not expect this tool to warn asset managers of an impending apocalypse, rather to offer them suggestions as to how their portfolio might behave in such a situation. “It is not a Doomsday approach,” says Ms Goldberg.

RiskMetrics offers clients a similar facility – the ability to pick out days with common characteristics (such as extreme volatility) within its set of historical data and analyse their behaviour.

Risk management in asset management now routinely includes some less high-tech techniques that many commenters welcome as being less of a box-ticking exercise. Stress testing, where a negative scenario is suggested and the likely impact on a portfolio calculated is all the rage.

This concept requires users to ask themselves what a negative scenario might look like. Consultant Watson Wyatt has come up with a list of 15 possible sources of extreme risk, from economic depression to war or a killer pandemic.

The trouble with this approach is that there is no guarantee these events would happen independently.

As Shakespeare said, “when sorrows come, they come not single spies but in battalions”. A global depression could easily lead to sovereign defaults, while the end of capitalism or fiat money (the system whereby money is money because a government says so) could be linked to war.

Watson Wyatt points out in a paper on the topic that “not all of these extreme risks can be hedged, or any hedge used is likely to be very imprecise”. The example they cite is a killer pandemic; even if it were possible to work out how likely such a pandemic is, that tells you nothing about how many people would die or whether some groups would be hit worse than others, so its impact is incalculable.

In events where the outcome is relatively straightforward – the end of fiat money would almost certainly lead to gold being the main store of value – the question arises as to how effective the hedge needs to be and how much an investor is willing to pay for it. A portfolio 100 per cent in gold would be entirely hedged against the collapse of fiat money, but might not seem a precaution worth taking.

Reverse stress testing is coming into fashion as well. It reverses the process of stress testing – instead of asking what would happen if x occurs and coming up with the answer “a loss of y”, it asks “what could trigger a loss of y?” in order to find out what x might be.

In answer to increasing demand for tools to understand extreme risk, the academic world is developing extreme value theory, a specialist branch of statistics that tries to use what data is available. This builds on the work of insurance actuaries over decades, as this is precisely what their task has consisted of.

An interesting point thrown up by EVT is that the left tails of return distributions are significantly fatter than the right. In English, this means extreme events (which happen in the tail of a distribution) are more likely to be negative (occurring on the left hand side of the graph) than positive; econometricians would say kurtosis is often accompanied by heteroskedasticity.

The number-crunching runs out of steam when looking for explanations for this, however, leaving it to behavioural theorists to talk about the irrational behaviour of investors.

Insurance Amendment Act is 'exciting' for Bermuda

2009-12-19T07:28:00.000-08:00

Original posted in the Bermuda Sun by Greg Wojciechowski:

Bermuda is a pioneer and leader of the offshore insurance industry and the third largest insurance market in the world - it comprises nearly 1,400 companies, has total assets of $442 billion and gross premiums of $142 billion.

At the heart of this insurance market is the Bermuda Stock Exchange (BSX), which has listed insurance companies and insurance-linked securities worth $39 billion.

Regulating is the Bermuda Monetary Authority (BMA), under whose auspices the Insurance Amendment Act 2008 came into effect in October 2009.

Described as an "exciting development for Bermuda" by Andre Perez, CEO of Horseshoe Group, the Act provides specific risk-based regulations for the establishment of special purpose insurers (SPIs) as a new class of insurer.

It recognises and facilitates the structure of insurance-linked securities (ILS) such as catastrophe bonds (cat bonds).

A listing on an internationally recognised stock exchange makes these securities significantly more attractive for potential investors.

The BSX has already successfully listed seven cat bonds with a combined value of $370 million, the most recent being the Montana Re Principal at Risk Variable Notes cat bond in December 2009.

SOLVENT

Once an SPI is licensed, attention is placed on the original insured, shifting the focus from the SPI to the ceding entity.

This is because the SPI is fully funded and therefore perpetually solvent.

The minimum capital requirement for an SPI incorporated in Bermuda is just $1 and it no longer has the same financial reporting and audit obligations as under the previous classification system, provided the issuer has met its regulatory obligations.

Also, provided all documents are presented correctly to the BMA, the SPI approval process can be completed within a week.

In addition, the BSX has specific regulations for ILS listings, which are not always mirrored by other jurisdictions. They focus on transparency, which has become even more important to the end-investors.

Cat bonds are an alternative asset class and are a compelling diversification tool due to their low correlation with global stock and real estate markets, being linked instead to natural disasters.

They are likely to be used more frequently as a mechanism for capital raising to ensure sufficient levels of coverage for catastrophic events.

Like every other asset class, they were impacted as a result of the global financial market dislocation. But since then, the cat bond market has recovered significantly, with the Swiss Re Catastrophe Bond Total Return Index rising 10 per cent in the first three quarters of 2009.

Some experts believe there is easily enough risk transferred in the market today to fuel a $50 billion per year market.

Bermuda is a leader in risk-based solvency regulation for the global insurance and reinsurance sectors and an economic success story.

Because of this, the island's indigenous (re)insurance industry has developed strongly and now supports the global insurance industry, particularly in the U.S.

Bermuda provides approximately 40 per cent of U.S. and EU broker placed catastrophe covers.

It is the most important offshore supplier of insurance, reinsurance and payer of property and casualty losses to the U.S.

Andre Perez, CEO of Horseshoe Group, said: "Since Hurricane Andrew, Bermuda has emerged as the foremost property catastrophe reinsurance market in the world and this new SPI regulation is a step towards consolidating this lead by making it easier for cat bonds to be done out of Bermuda." Those suspicious of offshore jurisdictions should be comforted by the BMA's strengthened regulations governing money laundering and terrorism financing.

An independent Financial Intelligence Agency has also been formed to monitor suspicious transactions.

TRANSPARENCY

After signing 18 tax information treaties, Bermuda has secured its place on the OECD's 'white list' - a high profile recognition the country is committed to tax transparency - and is fully implementing established international standards.

It is also a vice-chair on the steering group of the OECD's new Global Forum. Unlike some other British overseas territories, Bermuda is financially independent and has remained so during the global financial upheaval.

Bank of Butterfield's successful $200 million preference share offering and BSX listing in the first half of this year, guaranteed by Bermuda Government, is a perfect example of the island's ability to cope on its own and demonstrates that there is a healthy investor appetite here.

Guy Carpenter say between $1.2 and $2.2 billion of cat bonds could be issued in the fourth quarter of 2009 -40 to 55 per cent of the issuance for 2009. A fourth quarter accounting for more than 40 per cent of any year's total issuance has only been reached once, in 2004.

Bermuda can play an important role in supporting this growing market by providing listing services for these securities on an internationally recognised stock exchange.

It is an exciting opportunity for the island in the convergence of the capital and insurance markets.

Mr. Perez said: "The Cayman Islands have been a leader on cat bonds but Bermuda now provides a viable alternative."

PERILS Index Used for ILW Transactions

2009-12-17T07:58:00.000-08:00

Zurich, 17 December 2009 – PERILS AG, the independent Zurich-based company established to aggregate and provide industry-wide European catastrophe insurance data, has today announced the placement of the first two insurance risk transactions based on a PERILS industry loss index.

The transactions relate to Industry Loss Warranty (ILW) reinsurance contracts which will provide protection against a major European windstorm event. One contract involves Credit Suisse Asset Management as the protection provider and Munich Re as the counterparty. The other was arranged by Willis Re with the counter-parties remaining unnamed.
PERILS will provide an independent authoritative source of data to determine the property market loss arising from a large windstorm event affecting Europe. This information will be used to produce an index value to determine the payout of the protection under the ILW contracts.

Commenting on the transaction, Luzi Hitz, CEO of PERILS, said: “These two transactions are the first ILWs to use a PERILS index. This is an important development, as it illustrates the key role which PERILS plays, as an independent loss aggregator, in enabling the use of industry loss triggers for European windstorm events.”

Niklaus Hilti, Head of Insurance Linked Strategies at Credit Suisse, added: “The use of a PERILS industry loss index in this ILW reinsurance contract is a key milestone in the development of a more mature and liquid market which is in the best interest of both reinsurers and investors. We are happy to support PERILS together with Munich Re.”

Hans Joachim Thoenes, Head of Retrocession at Munich Re, added: “Munich Re fully supports the PERILS initiative. Our main objective is to contribute to the creation of a more liquid and standardised ILS and derivatives market for European windstorm risk which is to our own benefit, that of our clients in the insurance industry and potential investors. The launch of PERILS is, in our opinion, an important step in this direction. We are proud to have been able to set up with Credit Suisse Asset Management the first transaction in the market based on a PERILS industry loss index.”

Henry Kingham, Executive Director of Willis Re, commented: “We are delighted to have worked closely with Luzi and the team on the first brokered PERILS transaction. As we have commented before, PERILS helps deal with the long standing issue of an independent European wind loss index and will hopefully mean the expansion of indexed trades triggering off European windstorm events.”

Four more deals to take cat bond issuance past $3 bln

2009-12-07T07:58:00.000-08:00

Posted on Reuters by Sarah Hills:

Total issuance of catastrophe bonds this year should surpass the $3 billion target earmarked by many market analysts, with four more cat bond deals still to close before the year's end, according to market sources.

Swiss Re's Successor X marks the fifteenth catastrophe bond to be issued in 2009, while French reinsurer Scor is marketing its Japanese earthquake and European windstorm at 75 million euros, which is expected to close this month.

Meanwhile, Swiss Re is said to be marketing its California earthquake transaction, Redwood XI, and up to five companies are involved in US Northeast hurricane bond Longpoint Re, according to a number of market sources.

"To achieve a nearly $3 billion figure in issuance is a considerable success given the challenges the sector and the broader economic environment have faced in the last 24 months," Michael Halsband, a vice president on the financial institution structured finance desk at Goldman Sachs, told Reuters.

"Considerable discipline has been brought to the market in 2009, as witnessed by the successful reintroduction of tighter collateral structures and greater transparency -- both key elements where the investors and sponsors interests are aligned."

One market investor, who did not want to be named, said there may also be another deal in the market that is "most likely to cover California earthquake as well," but refused to give more details.

Currently, there is $450 million of issuance capacity left in the market for the cat bond sector to hit the target figure of $3 billion. The close of Multi Cat Mex at $290 million, Montana Re at $175 million, Vita Capital IV at $75 million and Successor X at $150 million in the fourth quarter has brought issuance up to $2.550 billion.

With no cat issuance in the last quarter of 2008, due to the state of capital markets during the credit crisis, a year end total of $3 billion is seen as a return to form for the insurance-linked securities (ILS) sector.

Chi Hum, global head of distribution, GC Securities, Guy Carpenter, said tighter and more innovative collateral structures has taken away the credit risk of a transaction.
"The market has been able to structure a treasury collateral package that essentially takes away credit risk, which is an extreme solution, but a reaction to the market dislocation last year."

A new range of products means there is no longer one approach to collateral -- the total return swap (TRS). The failure of Lehman Brothers in September 2007, which played a counterparty role in several cat bonds, highlighted the potential weaknesses of TRS collateral solutions.

In addition, movements in pricing should encourage a number of sponsors to come to market in first half of 2010. The tightening of terms and conditions and continuing discipline in the structuring of the transactions will allow the market to continue to stabilise as it matures further.

"Risk placed in the fourth quarter, when compared to comparable risk placed in the first two quarter of 2009, has seen pricing come in as much as 300 basis points," added Halsband.

S&P rating Longpoint Re’s two classes of US hurricane risk

2009-12-07T07:57:00.000-08:00

Posted on Reuters by Sarah Hills:

Standard & Poor's (S&P) Ratings Services has assigned its ratings to the Series 2009-1 Class A and Class B notes exposed to losses from U.S. hurricanes in the covered area issued by Longpoint Re II Ltd.

S&P has rated the $250 million bond in two tranches, Class A and Class B, both at 'BB+'. The Class A notes ($100 million) provide three years of protection on a per-occurrence basis against certain U.S. hurricanes, the Class B notes ($150 million) provide similar protection but over a four year risk period.

The risk modelling is based on Risk Management Solutions' (RMS) model RiskLink Version 9.0.

To see the pre-sale report, click here.

Longpoint Re II is a special-purpose Cayman Islands exempted company licensed as a Class B insurer in the Cayman Islands.

Travelers Indemnity Co. (Travelers Indemnity) will be the insurance company obtaining protection from U.S. hurricanes in the covered area from Longpoint Re II. Travelers Indemnity is the second-largest operating company after St. Paul Fire & Marine Insurance Co. based on premiums written (24.79% versus 23.29%) of the 35 operating subsidiaries of Travelers Cos. Inc.

Travelers' insurance subsidiaries continue to generate above-average industry results. The company is maintaining strong capital and liquidity through the difficult market conditions and is managing sizable risks in an excellent enterprise risk-management structure. On Aug. 11, 2009, Standard & Poor's revised its outlook on Travelers and its operating subsidiaries to positive from stable.

Swiss Re kick starts mortality bond issuance in ILS sector

2009-11-30T07:55:00.000-08:00

Postedon Reuters by Sarah Hill:

Swiss Re has closed the first excess mortality bond in 2009 at an upsized $75 million in a transaction that shows a diversification away from natural catastrophe perils in the Insurance Linked Securities (ILS) sector.

In the reinsurer's latest life insurance securitization Vita Capital IV Ltd, the transaction provides Swiss Re with cover against severe population mortality in the U.S. or the UK. The deal covers a five-year risk period ending in 2014 and has been assigned a BB+ long term debt rating by Standard and Poor's.

Swiss Re' head of non-life risk transformation, Martin Bisping, told Reuters that after the re-opening of the ILS market earlier this year, the sector has seen a healthy pipeline of catastrophe bonds, with 13 bonds issued so far this year at a total of above $2.2 billion volume.

"It is a natural evolution of the market that the first mortality bond should be issued this year - and Swiss Re is glad to revive this risk transfer," he said.

Currently, Swiss Re and Munich Re have mortality bonds in the market. Vita IV is the fourth bond in Swiss Re's excess mortality series, while the reinsurer also sponsors Osiris Capital, which is set to mature Jan 15 2010. Swiss Re has issued a total of $2 billion in mortality bonds.

In February 2008, Munich Re transferred $100 million of risk to the capital markets with a five-year bond sold via special purpose vehicle Nathan Ltd. The current outstanding volume for mortality bonds stands at $1.68 billion.

Investors in the market said more companies need to become more active on the mortality side. "This issuance is a positive step for the market," said one investor, who did not want to be named. "In the mortality sector, models will become more reliable if there are more data points to calibrate, but we need to see more investors come into the market," he said.

But, Risk Management Solutions (RMS), who provided the risk modelling and analysis, said that while ILS had a slow start in 2009, the Vita bond demonstrates that interest in this asset class is accelerating.

John Stroughair, head of the RiskMarkets group of RMS Consulting, said this was the first time an excess mortality securitization has been structured using a probabilistic catastrophe model rather than relying on historical data and is unique in covering an existing event -- the H1N1 flu pandemic.

"There are not many mortality bonds in the market, but the life insurance industry is much bigger than the ILS sector - if we can attract new investors from the life insurance space, it would help to increase ILS."

He said this approach for modelling could also be used for longevity transactions - in which investors could securitise against the risk of people living longer than expected. "The way the Vita IV bond was modelled was positively received by the market - as proved by the upsizing to $75 million. This bodes well for the ILS market next year," he said.

The industry's consensus estimate for cat bond issuance in the whole of this year is $3-4 billion. Swiss Re's Vita IV and its recent Multicat Mex ILS transaction last month, added to a greatly accelerated fourth-quarter issuance rate.

Meanwhile, three other cat bonds are currently active in the market and expected to close by the end of 2009; Flagstone Re's US hurricane and earthquake bond Montana Re, Swiss Re's Successor X covering California earthquake and North Atlantic hurricane risk, and Scor's recently rated Atlas Re -- protecting major Japanese earthquake and windstorm risk in selected countries/regions in Europe.

The sector can expect to see an additional two more cat bond transactions closed before Christmas according to investors.

Atlas VI Capital Ltd catastrophe bond being prepared for launch by SCOR

2009-11-24T07:54:00.000-08:00

LONDON (Standard & Poor's) Nov. 24, 2009--Standard & Poor's Ratings Services said today that it assigned a preliminary credit rating of 'BB-' to the series 2009-1, class A notes to be issued under the principal-at-risk variable rate note program, Atlas VI Capital Ltd. This will be the first series of notes issued under this program.

The notes will be exposed to major Japanese earthquake and to windstorm risk in selected countries and regions in north and west Europe, between December 2009 and April 2013.

SCOR Global P&C SE will be the counterparty to the risk transfer contract. It is the principal property & casualty operating company in a group of affiliated companies (SCOR SE). SCOR SE transacts reinsurance business worldwide and is one of the largest global reinsurers in terms of premium written and capital.

There are four risk periods for this transaction. The first is from the issuance date until March 31, 2010. The following three periods begin on April 1, 2010, 2011, and 2012, respectively.

Atlas VI provides cover to SCOR Global P&C against losses suffered between December 2009 and April 2013. SCOR Global P&C may choose to extend the transaction in one-month increments for up to three months, but this will not extend the risk period.

Swiss Re obtains USD 75 million of extreme mortality risk protection through new Vita Capital programme

2009-11-24T07:53:00.000-08:00

Swiss Re today announced the transfer of USD 75 million of extreme mortality risk in the U.S. and UK to the capital markets through a new VITA securitisation programme:

Swiss Re has entered into a transaction with VITA Capital IV Ltd. (“Vita IV”) to receive up to USD 75 million of payments in the event of severe population mortality in United States or the United Kingdom. The agreement covers a five-year risk period starting in the issuance year and ending in 2014. Vita IV, in turn, has issued notes linked to this risk into the capital markets. The notes are rated “BB+” by Standard & Poor’s.

This is a continuation of Swiss Re’s hedging strategy, enabling the company to manage extreme mortality exposures in a capital-efficient manner. Swiss Re’s Chief Underwriting Officer, Brian Gray, commented: “This Vita transaction will help us to manage our exposure to peak mortality risk in a capital efficient way, to meet increased client demand for extreme mortality risk protection and, ultimately, to position us for further growth.”

Swiss Re Capital Markets acted as sole manager and bookrunner on the note issuance. Collateral for the Vita IV notes will initially consist of securities issued by the International Bank of Reconstruction and Development. Risk modelling and analysis was performed by Risk Management Solutions, Inc.

Swiss Re has a history of securitizing its life risks, obtaining over USD 1.4 billion in extreme mortality risk protection in its predecessor Vita programmes.

Notwithstanding the current media focus on the H1N1 virus, the Vita IV notes offering was a successful placement for Swiss Re. Christian Mumenthaler, Head of Swiss Re’s Life & Health business commented: “This transaction is another example where we sustain our leadership in the life securitisations market.”

The Vita IV notes were sold in a private placement pursuant to Rule 144A of the U.S. Securities Act of 1933, as amended, (the “Securities Act”) and have not been registered under the Securities Act or any state securities laws; they may not be offered or sold in the United States except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws.

Cat bonds aim for growth despite flat reinsurance

2009-11-23T07:52:00.000-08:00

Posted on Reuters by Sarah Hill:

The Insurance Linked Securities (ILS) sector will continue to grow despite expectations for flat reinsurance prices next year, reinsurance intermediary Aon Benfield said.

Historically, catastrophe bond activity is most active when reinsurance rates are particularly hard, causing investors to look for alternative mechanisms to spread capital. But market expectations are generally for flat reinsurance pricing in 2010.

However, at the Fitch Ratings Insurance Roadshow on Monday, panellist Des Potter, managing director of Aon Benfield Securities, said ILS sponsors were being attracted by the multi-year, collateralised nature of cat bonds.

"Cat bond pricing continues to tighten to levels that provide a compelling alternative and complement to traditional reinsurance," he said.

This year has seen new sponsors, such as Assurant and the North Carolina Wind Pool, enter the cat bond market in addition to repeat issuers including Scor, Chubb, Liberty, Allianz, USAA and Hannover Re.

Potter said there had been $2.1 billion in cat bond issuance so far in 2009, and with two deals in the market at the moment, that figure would reach $2.3 billion. He declined to elaborate on the two deals currently being marketed.

He said he expected a further four to six deals by year-end, which would take new issuance for 2009 above $3 billion. Next year, Potter believes issuance could exceed $4 billion.

TOTAL RETURN SWAPS
Rolf Tolle, franchise performance director at Lloyd's of London, said ILS activity might increase further, but this would require a resolution of the status of the guarantor of Total Return Swaps (TRS).

The failure in September 2008 of Lehman Brothers, which played a counterparty role in several cat bonds, highlighted the potential weaknesses of TRS collateral solutions.

Unless this problem is solved, Tolle said, most of the capacity for high-risk securitisations will be delivered by the traditional reinsurance market, and ILS will remain a "top-up".

Potter said most new cat bond issuance would be for U.S. perils, though there was also growing investor demand for non-U.S. perils such as Japanese earthquake and European wind.

The planned launch next year of PERILS, an independent data loss reporting company for the European insurance industry, will encourage cat bond issuance based on European wind perils, he added.

Potter noted that the Lehman disaster had prompted more transparent collateral solutions to be introduced for cat bonds this year.

The first four bonds of the year -- Atlas V, Mystic II, East Lane III and Ibis Re -- had improved TRS collateral solutions, with tighter requirements on permitted investments and restrictions on the credit quality of the swap counterparty.

The market has now moved towards "risk-free" collateral using money market funds or government-backed securities, as in the cases of Blue Fin II, Residential Re 2009 and Parkton Re. Hannover Re's Eurus II, meanwhile, was based on a tri-party repurchase agreement between an investment bank, the issuer, and clearing house Euroclear.

Third Quarter 2009 Cat Bond Update

2009-11-16T14:38:00.000-08:00

Posted on GCCapital.com by David Priebe:

The third quarter is usually quiet for the catastrophe bond market, and 2009 was consistent with past years. Issuers completed two transactions, bringing USD412 million in risk capital to the market. Nonetheless, risk capital issued was up by a third relative to the same quarter last year, as both catastrophe bonds issued were upsized considerably. The consensus estimate for the entire year remains USD3 billion to USD4 billion, implying a strong fourth quarter for primary issuance.

The two issuances, including Parkton Re Ltd, on which GC Securities acted as co-lead manager and joint bookrunner, were among only a few issuances to be upsized this year. The initial target placement of USD125 million ultimately led to a USD200 million transaction. For the entire year, 11 catastrophe bonds were issued, for USD1.79 billion in risk capital. In terms of risk capital this is 33.5 percent lower than the first three quarters of 2008 in which 13 issuances were completed, yielding USD2.69 billion in catastrophe protection.

A strong issuance pipeline and increased financial market stability have led to a consensus estimate of approximately USD3 billion to USD4 billion for full-year issuances. This would entail USD1.2 billion to USD 2.2 billion in new risk capital and would constitute 40 percent to 55 percent of the year’s issuance — making it the most active quarter of 2009. A fourth quarter accounting for greater than 40 percent of any year’s total issuance has been reached only once (in 2004)

Though a USD1.2 billion to USD2.2 billion fourth quarter may seem to be a stretch, several factors suggest that it could be realized. In the third quarter, both transactions were placed within (or, in the case of Parkton Re Ltd., below) spread guidance and well inside the spread levels associated with transactions completed in the first half of the year. Both were also upsized significantly relative to initial placement targets. And, the easing of credit markets and increased investor demand provide further support. A favorable wind season this year, based on insured losses, is also making catastrophe bonds more attractive to both issuers and investors.

Yields have declined on similarly rated alternative investments. As an example, the yield on BB-corporate debt, which was near an all time high at the beginning of 2009, has declined by more than 45 percent during 2009 year to date. The general easing of prevailing yields across assets that are often compared to cat bonds should make it easier for insurance linked securities (ILS) investors to accept lower spreads while still generating competitive returns.

The tightening of spreads is bringing the ILS market back from the unusually wide levels sustained in the first half of 2009. Elevated catastrophe bond spreads — especially when contemporaneous to adequate traditional reinsurance capacity that has not increased its pricing by the same magnitude as the capital markets from 2008 to 2009 — have had a dampening effect on issuance activity, particularly from reinsurers.

Sponsors that were not inclined to issue during the first two quarters of 2009 because of pricing concerns may renew interest in catastrophe bonds, as the other benefits of catastrophe bond protection (e.g., multi-year fixed pricing, fully collateralized cover and a sourcing capacity from an alternative providers relative to traditional reinsurance and retrocession providers) not only remain, but will now be attainable at more favorable price points.

Pension Benefit Guaranty Corporation Deficit Increases

2009-11-14T09:37:00.000-08:00

Posted on Calculated Risk:

The Pension Benefit Guaranty Corporation (PBGC) is the federal agency that guarantees pensions for 44 million Americans. The PBGC deficit doubled over the last six months to $22 billion ... but this is only just the beginning as the agency's potential exposure to future losses increased sharply.

From the Pension Benefit Guaranty Corporation (PBGC): PBGC Releases Annual Management Report for Fiscal Year 2009

The Pension Benefit Guaranty Corporation (PBGC) ended fiscal year 2009 with an overall deficit of $22 billion, according to the agency's Annual Management Report submitted to Congress today. The result compares with the $11.2 billion deficit recorded at the previous fiscal year-end on September 30, 2008.
...
The Annual Management Report classified 27 large pension plans with total underfunding of $1.64 billion as probable losses on the PBGC balance sheet. The report also shows that the agency's potential exposure to future pension losses from financially weak companies increased to about $168 billion from the $47 billion booked in fiscal year 2008.

"Exposure to possible future terminations means that we could face much higher deficits in the future," said Acting Director Vincent K. Snowbarger. "We won't fail to meet our obligations to retirees, but ultimately we will need a long-term solution to stabilize the pension insurance program."
emphasis added

With companies moving away from defined benefit plans, there will be fewer companies paying for insurance in the future - and the "long-term solution" will probably involve some sort of bailout.

Munich Re: Insurance-linked securities - the market celebrates its comeback

2009-11-13T12:40:00.000-08:00

Following a short, sharp slump in demand, insurance-linked securities are back in business. Apart from a temporary increase in price, the financial crisis has in no way altered the fundamental advantages of insurance-linked securities as an attractive complement to traditional reinsurance. Munich Re’s Risk Trading Unit gives our clients access to the whole range of products and services that this securitisation segment has to offer.

After insurance-linked securities (ILS) had successfully withstood the crisis on the securitisation market for some considerable time, they then felt the full force of the Lehman Brothers’ bankruptcy in the autumn of 2008. Insurance securitisation issues came to a complete standstill in the fourth quarter of 2008, suffering the same fate as most other financial markets. However, the demand for financial instruments that securitise nat cat risks from property insurance and transfer them to the capital market has since increased significantly, again attaining the average volume of past years. Securitisation transactions for nat cat bonds alone had reached almost US$ 2bn by the end of July. Given the backlog demand involved, we fully expect this positive trend to continue and predict an issue volume in the region of US$ 3bn for the whole of 2009.

The Current ILS Market

The record figures from 2007, when cat bonds totalling some US$ 7bn were placed, are unlikely to be repeated. However, there are strong arguments for transferring insurance risks to the capital market in the form of securitisation. Firstly, in times of hard markets when conventional reinsurance is expensive, capital-market products such as ILS become more attractive to sponsors. As issuers of cat bonds, (re)insurers are able to ease their equity capital or avoid risk concentration by transferring risks to the capital market. Finally, ILS are a welcome reinsurance instrument where no traditional capacity is available. This applies, for example, to pandemic covers in life or to business interruption in property and casualty.

The financial crisis has actually enhanced demand for alternative risk transfer: as some suppliers of traditional reinsurance ran into difficulties, capacities for US peak risks disappeared and prompted primary insurers to consider alternative risk transfer in order to diversify their sources of reinsurance. The financial crisis showed investors that ILS offer an investment opportunity that is uncorrelated with conventional investment classes. The returns on diversified ILS portfolios were positive in 2008 in spite of the financial crisis, unlike the returns on almost all other investment classes.

However, the Lehman insolvency did change the structure of ILS. As the most recent issues on the cat bond market show, investors are more acutely aware of the credit risk, i.e. the credit risk of the assets in the collateral backing a cat bond. A higher level of security is achieved, for example, by investing the paid-in capital in government bonds or in investments with a similar security. Nevertheless, the risk premium remains higher than before for the time being, so that there are only certain segments in which cat bonds can compete with the price of traditional reinsurance. Cat bonds are currently in especially high demand to cover the peak risk US wind. If traditional capacity is available in sufficient amounts and at favourable prices, the current high returns on the capital market make securitisation solutions more difficult. In this connection, Munich Re’s objective is to develop those investor segments that reward the diversification effect of ILS (also within the ILS investment class) with more favourable risk premiums (e.g. pension funds) in order to secure the prerequisites for the further development of the ILS market.

ILS versus reinsurance

Munich Re regards insurance-linked securities as an attractive and useful complement to traditional reinsurance. They are particularly suitable for reducing peak exposures, developing additional sources of capacity or for overcoming innovation gaps. However, ILS can never fully replace traditional reinsurance because only certain risks that can be clearly quantified and modelled are suitable for transfer to the capital market. More complex risks whose evaluation requires not only quantitative expertise but also a high level of market and underwriting experience remain firmly a matter for reinsurers.

Munich Re services the whole value chain

Our objective is to expand and develop the market for cat bonds as an additional source of capacity. Direct contact to a broad investor basis is every bit as important as our know-how in order to successfully conclude placements. For our clients, cat bonds usually constitute just one element of a comprehensive reinsurance concept, so that a good market overview, a wide range of products and speedy implementation are at the forefront of our services.

As a full-range provider, we are active in the ILS segment on a variety of levels: we transfer our own risks to the capital market, act as an investor on the cat bond market and, through our Risk Trading Unit, offer our clients a wide range of ILS services – from product development to structuring and placement. The combination of our risk capacity and our understanding as a risk carrier enables us to develop individual ILS solutions which optimally link alternative risk transfers with traditional reinsurance products. As part of our latest cat bond transaction “IANUS Capital Ltd.”, we have added our own risk to a client’s risk to be transferred and thus improved the economic viability of the concept and increased the attractiveness of the transaction for the client.

Outlook – ILS under Solvency II

ILS have become firmly established with investors as an alternative investment class and with insurers as an instrument of risk transfer. Under the new framework conditions of Solvency II, ILS will continue to gain in importance for insurers as the impact of risk transfer on the balance sheet will no longer be based on the form of the instrument but on its economic effect (“substance over form” principle).

Other advantages of ILS under Solvency II result from the explicit consideration of the counterparty risk when measuring the amount of solvency capital to be held. As the transactions are usually fully secured (AAA security), the ceding insurer has lower capital requirements in this respect compared with a traditional reinsurance solution.

How Well Prepared Are Americans for Retirement?

2009-11-13T04:25:00.000-08:00

Posted on the Baseline Scenario by Andrew Biggs:

After our exchange regarding Tuesday’s blog on The Retirement Problem in the Washington Post (which started over at AEI’s Enterprise blog and continued here), James generously offered to let me guest-post my thoughts on Americans’ level of preparation for retirement. Overall I’m not so pessimistic, although there are surely problems that must be addressed. But most of the detailed research out there points to problems, but not a crisis.

Both James’s analysis and my own response were built on relatively simple projections using stylized workers who pay into Social Security and participate in 401(k) plans. These illustrations are useful for fleshing out basic issues – plus, in this case, finding how the SSA’s online benefit calculator may have skewed some of the results.

But the best research on retirement preparedness is more involved than this. Most analysis of current retirees uses survey data, such as from the Health and Retirement Study (HRS), the Survey of Income and Program Participation (SIPP), the Fed’s Survey of Consumer Finances (SCF) and the Current Population Survey (CPS). Each survey has strengths and weaknesses.

In addition, broader models of the population are built using this survey data. These models allow for simulations of how policy changes affect current retirees, as well as projecting the population into the future. Such comprehensive models include the Social Security Administration/Urban Institute MINT (Modeling Income in the Near Term) model, the Congressional Budget Office’s CBOLT (CBO Long Term) and the Policy Simulation Group’s PSG suite of models, used by the Government Accountability Office and the Department of Labor for Social Security and private pension projections. While these models, like any others, rely on assumptions regarding a large number of factors, they are also the most closely scrutinized to ensure these assumptions are consistent with current trends.

I’ll first run through what some of my own work has found, and then highlight some work from elsewhere. This paper, written with Glenn Springstead when I was at SSA, used the MINT model to analyze replacement rates for current retirees and, using projected data, for individuals retiring in the 2040s. We looked at income from a wide variety of sources, including Social Security, defined benefit and defined contribution pensions, earnings, co-resident income and government programs such as SSI. We examined individuals aged 64-66 in 2005 and projections for individuals aged 64-66 in 2040. The typical couple in 2005 had total retirement income equal to 185% of final earnings, while the median projected couple in 2040 has a replacement rate of 131%. Now, these are projections, but bear in mind that the MINT model is probably the most comprehensive and best-vetted projection model of retirement income, with a large number of economists, demographers and social scientists working on it and regularly assessing its results.

As second paper used the Policy Simulation Group models, which look only at Social Security and private pensions. In this paper I used a different definition of replacement rates and also adjusted replacement rates to account for differences in household size and the number of children. (Larger households have economies of scale; children consume income during working years that doesn’t need to be replaced in retirement, so childless couples would need to save more for retirement than couples with children.) Here I looked at people born in 1940 and 1960 to track replacement rates from today through the 2020s. The median Social Security/pension replacement rate for the 1940 cohort was 92 percent while the median for the 1960 cohort was 82 percent. Working just an additional year would bring the 1960 birth cohort up to 1940 levels. While replacement rates do decline over time, due to a rising Social Security retirement age and declining DB pension coverage, most people at most income levels are doing ok.

This well-received paper by John Karl Scholz and Ananth Seshadri of the University of Wisconsin–Madison and Surachai Khitatrakun of the Urban Institute uses the HRS to examine how well the Baby Boomers are prepared for retirement. It uses a more sophisticated measure of retirement readiness than the replacement rates I used, but the basic idea is similar. They find that

over 80 percent of HRS households have accumulated more wealth than their optimal targets. These targets indicate the amounts of private saving households should have acquired at the time we observe them in the data, given their life cycle planning problem and Social Security and defined-benefit pension expectations and realizations. For those not meeting their targets, the magnitudes of the deficits are typically small.

In a draft follow-up paper Scholz and Seshadri reach similar conclusions for younger cohorts.

Now, there have been good research projects that have come to alternate conclusions, the most prominent being the National Retirement Risk Index generated by the Center for Retirement Research at Boston College. Without doing a very detailed nuts-and-bolts comparison of the CRR’s model to the others it’s hard to say exactly what’s driving the differences. While I really like the CRR’s work, I would say that models like SSA’s MINT are more comprehensive and have been around longer, so I would tend to favor those results. CRR’s model was built for the NRRI research project and I’m not sure its general results fully match those from other models.

None of this is to say retirement preparation doesn’t face problems. DC plans like 401(k)s present challenges to savers and both participation rates and asset management haven’t been as good as we’d like, although policies to address both problems are being implemented. Likewise, Social Security is almost sure to reduce benefits in the future, at least for middle and high earners, and Americans will need to save more to make up for these losses. But the key is to look closely at who’s unprepared for retirement, why, and what we should or can do about it. When we think about a “crisis” in retirement saving, hasty solutions might make things worse rather than better.

Moody's withdraws ratings of Genworth insurance-linked securities

2009-11-11T04:19:00.000-08:00

New York, November 04, 2009 -- Moody's Investors Service has withdrawn the ratings of certain life insurance-linked securities sponsored by Genworth Financial, Inc. and insured by MBIA Insurance Corporation as detailed below. The following ratings were withdrawn, consistent with Moody's policy for rating insured notes when the financial guarantor is downgraded to below investment grade and there is no published underlying rating. Moody's approach to rating insured transactions is outlined in Moody's Special Comment entitled "Assignment of Wrapped Ratings When Financial Guarantor Falls Below Investment Grade" (May, 2008).

NOTES INSURED BY MBIA INSURANCE CORPORATION (which is currently rated B3 for insurance financial strength, negative outlook):

River Lake Insurance Company (River Lake I) (sponsored by Genworth Financial, Inc.):

$600 million of INC Money Market Securities, Series 2003-1 through 6 at Baa1

$200 million of INC Term Securities, Series 2005-1 at Baa1

$300 million of INC Term Securities, Series 2006-1 at Baa1

River Lake Insurance Company II (River Lake II):

$300 million of INC Money Market Securities 2004-1 through 3 at Baa1

$300 million of INC Term Securities, Series RLII 2005-1 at Baa1

$250 million of INC Term Securities, Series RLII 2007-1 at Baa1

River Lake Insurance Company IV Limited (River Lake IV):

$500 million of Class A Series A-1 Floating Rate Guaranteed Notes at Baa1

The Baa3 rating on the unwrapped Class B Floating Rate Subordinated Notes remain under review for possible downgrade.

Rivermont Life Insurance Company I (Rivermont):

$315 million of INC Money Market Securities, Series RMI 2006-1 through 3 at Baa1

The last rating action on the MBIA-insured notes of River Lake I, River Lake II, and Rivermont was on February 18, 2009, when the rating of MBIA was downgraded to B3 from Baa1, and the Baa1 insured notes were placed under review direction uncertain. The last rating action on the unwrapped subordinated notes of River Lake IV was on May 26, 2009 when the rating was placed on review for possible downgrade.

The River Lake I, River Lake II, River Lake IV, and Rivermont underlying ratings were assigned by evaluating factors believed to be relevant to the credit profile of the notes such as (i) the demographics and actuarial experience of the referenced block of (re)insurance business, (ii) relevant industry experience for similar products/underwriting, (iii) review of independent actuarial report, including assumptions underlying projected cash flows, (iv) expected loss and probability of default estimated via stochastic and deterministic modeling of the insurance cashflows and the performance of invested assets, and (v) other factors believed to be applicable to the assessment of the creditworthiness of the transaction, such as a review of the structural, legal, and regulatory risks. Other methodologies and factors that may have been considered in the process of rating these securities can also be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab.

River Lake I, River Lake II, and Rivermont (domiciled in South Carolina), and River Lake IV (domiciled in Bermuda) are special purpose reinsuers for the purpose of funding excess reserve requirements associated with distinct blocks of business ceded by Genworth Life and Annuity Insurance Company (GLAIC, A2 insurance financial strength, negative outlook) which is an operating company of Genworth Financial, Inc. (NYSE: GNW, Baa3 senior debt, negative outlook). The reinsurance agreements between GLAIC and River Lake I, River Lake II, and River Lake IV cover defined blocks of level premium term life policies subject to the statutory reserve requirements of Regulation XXX. The reinsurance agreement between GLAIC and Rivermont covers defined blocks of universal life policies subject to the Actuarial Guideline 38 (AXXX).