Click to edit Master title style Surviving Financial Hurricanes: How innovative E-CAT (Economic Catastrophe) insurance and reinsurance can mitigate the

Click to edit Master title styleSurviving Financial Hurricanes: How innovative E-CAT (Economic Catastrophe) insurance and reinsurance can mitigate the impact of the next financial crisis and save your business.

Speakers:

• Jonathan Young, Chief Executive Officer, Boston Re Ltd.

• Alex Dubitsky, Chief Executive Officer, Awbury Insurance Ltd.

Moderator:

• J Oliver Heyliger, Managing Director

Willis Management (Bermuda) Limited


Overview

• The past decade has seen very unusual events in both the natural catastrophe market and the financial markets

• In the nat cat market, 2005 was a watershed year, disrupting the previous market structure and pricing

• In the financial markets, the financial crisis of 2007-2008 disrupted the previous business structures and methodologies

• Regulatory response to the 2008 crisis has largely been to require more capital be held against risks

• These events have caused new synergies between reinsurers and financial institutions


The Re/insurance Financial Crisis of 2005

• 2005 = Hurricanes Katrina/Rita/Wilma

• Record number of hurricanes, number of major hurricanes, number of hurricanes to hit the US.

• Record losses constricts supply of re/insurance

• Disruptive event = re/insurers unprepared for the extent and severity of the damage (the nat cat Black Swan emerges)

• Natural Catastrophe rates rocket up 73% as a result

• This excess return attracts third party capital such as Pension Funds, Hedge Funds, and other non-insurance financial institutions

• Financial institutions seek direct exposure to natural catastrophe risks


Third Party Capital provision of Reinsurance

• After 2005, third party capital makes definitive inroads to the reinsurance market (largely in US Quake and Windstorm in the form of simple securities such as ILW’s and Cat Bonds)

• Third party capital takes up the slack of diminished supply of reinsurance in the market after 2005 creating downward pressure on rates

• Primary insurers like various aspects of third party capital reinsurance e.g. reduced counterparty credit risk, greater diversification of counterparties, ability to lock in multi-year coverage through some cat bond structures

• Reinsurers react in different ways to the new providers but all begin to suffer on the underwriting returns for prop cat


The Global Financial Crisis of 2007-2008

• The Global Financial Crisis of 2007-2008 is the realisation of many extremely rare events in a short time period

– As David Viniar, CFO of Goldman Sachs during 2008 said: “We were seeing things that were 25 standard deviation events, several days in a row”

• Investors realise that modern portfolio theory (a diversified portfolio) doesn’t offer much protection during a crisis of this magnitude as all financial assets become similarly correlated during such extreme events

• Banks reassess both their models and their business models

• Regulators react through a panoply of regulation which boiled down to: more capital

• New regulations require different capital requirements based on the class and nature of the asset held or the business engaged in

• Even demonstrably remote risks require sizeable capital buffers held against them


Convergence: First Wave (2008-2010)

• Asset managers and investors burned during the Crisis when all assets seemed to collapse in unison started looking for returns with a much lower correlation to traditional financial markets

• The Insurance Linked Securities (ILS) market born out of the wreckage of 2005 offered a (relatively) high yielding investment with a very low correlation with traditional financial markets

– A stock market collapse does not cause a hurricane (but a hurricane can effect the stock market e.g. Sandy)

• This combined with primary insurer’s greater comfort with the third party capital format caused ILS to be a truly competitive force which now accounts for 16% of the $300b cat reinsurance market in the world (up from 3% in the late 1990’s)*

* Source: McKinsey & Company, “Could Third-Party Capital Transform The Reinsurance Markets?”www.mckinsey.com/.../mckinsey/.../Insurance/Could_third-party_capital_ transform_the_reinsurance_markets.ashx


Convergence: First Wave Consequences

• Third party capital erase excess returns by flooding the nat cat reinsurance market with supply which drives rates into single digits

• At the same time, Quantitative Easing (“QE”) in the US and Europe artificially compresses interest rate spreads on Western bonds

• Low interest rates make the ILS investments attractive relative to other returns available and come with a low correlation and the portfolio diversification it brings

• Low interest rates mean the asset side of reinsurance companies is getting hit hard at the same time as their liability side as underwriting returns shrivel

• Reinsurers search for returns elsewhere


Convergence: Second Wave (2010)

• Dodd Frank legislation signed into law in July 2010 and is followed by similar measure in Europe – all of which require more capital held against items on bank balance sheets

• Banks and other institutions look to transfer some of their risks to third parties so they can use the capital held against such risks for other ventures

• Hedge Funds were initially the key players in this area

• Competition from third party capital and bond return pressure from QE encourage reinsurers to seek risk that match the risk profile of their cat book while providing a better return plus some diversification

• Reinsurers find attractive risks on bank balance sheets for their portfolios

• A number of Hedge Fund Re’s (Third Point Re, ABR, Watford, Greenlight Re) take the best of both worlds = float from premiums matched against attractive risk-reward profiles on the asset side – particularly in credit


Economic Catastrophe Insurance and Reinsurance

• The market for very remote risks – the 1000 year event – has become more active and its participants more diverse

• Asset managers and hedge funds are seeking direct exposure to these events on the natural catastrophe, writing high attachment point wind and quake and migrating into casualty and direct liability

• Reinsurance companies are seeking some direct exposure to economic catastrophe events, writing a variety of low probability, high severity risks where the rewards are particularly attractive

• This has spurred new product development in both finance and reinsurance


Surely we’ve learned our lessons by now…

The financial system is now safe, and no new crises are coming…Right?

• While system adapts, crises do come again and again. Briefly:- 1987: Black Friday- 1997: Asian meltdown- 1998: Russian crisis- 2000: Dot-com bubble burst- 2008: Great Recession

So, what is coming next?


It is really hard to make predictions, particularly about the future…

How do we know if this time is different?

We can wait…• Bubbles and revolutions are only clear in hindsight:

- “Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications.”

- Alan Greenspan, 2005

- “Regulators who are required to forecast have had a woeful record of chronic failure. History tells us they cannot identify the timing of a crisis, or anticipate exactly where it will be located or who large the losses and spillovers will be.”

- Alan Greenspan, 2005

So what do we do?

If we have to change and move into new areas, how do we do it without the expertise?


How can we prepare for the unknowable?

Simple: Ensure that current needs are addressed by fully utilizing the full spectrum of tools and solutions available to you in the market

As the economy changes and grows ever more complex (and it always does), so do the challenges which confront captive insurers and the people who manage them.

Some examples:• Creating flexible programs, where the captive combines the role of a risk taker as

well as a pass through

• Solving burdensome collateral requirements

- Workers compensation insurance programs

- Plug and Abandonment

• Generating additional incremental revenue for the group by deploying the captive’s excess capital and risk capacity


Ask not what you can do for E-Cat; Ask “What is E-Cat and what can it do for me?”

What is E-Cat?

• E-Cat is an evolving area of insurance, which encompasses complex economic and financial risks, typically in pooled form, which are not adequately addressed by current insurance, capital market or banking products

• The solutions are typically custom tailored and non-commoditized

• Transactions are large, allowing participation from multiple reinsurers

It is very much in the blood of insurance industry to cover economic risks:

• Lloyds began by covering economic enterprises, such as merchant trade/ships against perils both natural (storm) and man-made (navigator’s error)

E-Cat can help anywhere there are complex financial or economic risks:

• Collateral alternative programs are one example

• Well over $1BN of alternative collateral arrangements have been put in place over the last 12 to 24 months alone, freeing cash and secured bank lines, and reducing cost


But can it make you money?

E-Cat can solve problems which can’t be solved using traditional insurance capital market solutions.

And it can make you money, if:• You have excess capital• You have excess risk capacity• You have unutilized risk capacity

You can participate in E-Cat deals as a reinsurer, standing behind established industry participants and sharing risk with leading global reinsurers who are already deeply involved in E-Cat risks

You can also invest your assets in funded E-Cat solutions:• Time horizons between 1 and 10 years • Earn significant premium above comparable market rates


What’s the Catch?

E-Cat is hard

• Each solution is unique and highly tailored

• Each transaction is individually negotiated and executed

• Often requires stepping outside of one’s “comfort zone”

E-Cat offers:

• Unique solutions to complex financial and economic risk issues

• An attractive source of new, incremental revenue

You just have to find the right partner


Disclaimer

This material is not investment research or a research recommendation. This material is provided for informational purposes, is intended for your use only and does not constitute an invitation or offer to subscribe for or purchase any of the products or services mentioned. The information provided is not intended to provide a sufficient basis on which to make an investment decision. The material is intended only to provide observations and views of the presenters, which may be different from, or inconsistent with, the observations and views of their employers. These observations and views may change at any time without notice. Information and opinions presented in this material have been obtained or derived from sources believed to be reliable, but no representation is being made as to their accuracy or completeness. None of the participants accepts any liability for loss arising from the use of this material. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances. Any discussions of past performance should not be taken as an indication of future results, and no representation, expressed or implied, is made regarding future results.

Documents

Click to edit Master title style Surviving Financial Hurricanes: How innovative E-CAT (Economic Catastrophe) insurance and reinsurance can mitigate the