The Handbook of Insurance-Linked Securities (The Wiley Finance Series)

The Handbook of Insurance-Linked Securities......Page 4
Contents......Page 8
About the Contributors......Page 18
Acknowledgements......Page 28
1 Introduction......Page 30
PART I NON-LIFE SECURITISATION......Page 36
2.1 Market overview......Page 38
2.2 Market dynamics......Page 43
2.3 The question of basis risk remains......Page 45
2.4 ILS and the credit crunch......Page 47
3 Cedants’ Perspectives on Non-life Securitization......Page 48
3A.1 Motivation for Allianz to take part in ILS activities......Page 50
3A.2 Objectives of insurance companies......Page 52
3A.3 Case study: Blue Fin Ltd......Page 53
References......Page 57
3B.1 Keeping risk vs transferring it......Page 58
3B.2 Reinsurance vs securitisation......Page 59
3B.3 Application to main P&C risks......Page 60
3B.4 Case studies: Aura re and Sparc......Page 61
3B.5 Limits and success factors to securitisation......Page 62
References......Page 63
3C Securitisation as a diversification from traditional retrocession......Page 64
4.1 General aspects......Page 66
4.2 Indemnity triggers......Page 67
4.2.2 Payout timing......Page 68
4.2.4 Transparency......Page 69
4.3.1 Parametric triggers (pure and index)......Page 70
4.3.2 Industry loss triggers......Page 72
4.4 Choosing the optimal trigger......Page 74
4.4.1 Comparison of trigger types......Page 75
4.4.2 Choice of trigger and alternative solutions......Page 76
5.1 Introduction......Page 78
5.3 Trigger types......Page 79
5.4.1 Key components of catastrophe models......Page 81
5.4.2 Uncertainty......Page 83
5.5.1 Source 1: Catastrophe model error/shortcomings......Page 84
5.6 Defining basis risk......Page 85
5.7.1 Measures for pro rata hedges......Page 87
5.7.3 Measuring positive basis risk......Page 88
5.8.1 Over-hedging......Page 89
5.8.3 Reset clauses......Page 91
Acknowledgements......Page 92
References......Page 93
6.1.2 Risk analysis......Page 94
6.1.5 Surveillance......Page 96
6.2.2 Indemnity vs non-indemnity triggers......Page 97
6.2.3 Risk factors......Page 99
6.2.4 Adjusted probability of default......Page 101
6.2.5 Application of methodology......Page 102
6.2.7 Multi-event criteria......Page 103
6.4.1 Capital model treatment of ILS......Page 104
6.4.2 Summary of basis risk analysis......Page 105
6.4.3 Sources of basis risk......Page 106
References......Page 111
7 Risk Modelling and the Role and Benefits of Cat Indices......Page 112
7.2.1 General overview......Page 113
7.2.2 Insurance-linked security triggers......Page 114
7.2.3 Basis risk......Page 119
7.3.2 Re-Ex – NYMEX......Page 122
7.3.4 Carvill Hurricane Index (CHI) – Chicago Mercantile Exchange (CME)......Page 123
7.3.5 Paradex......Page 124
7.4 Summary......Page 128
8.1.1 The distribution of the notes......Page 130
8.1.2 Application of the anti-fraud provisions of the federal securities laws......Page 131
8.1.4 Provision of information......Page 132
8.2.1 Important terms......Page 133
8.2.2 ERISA considerations......Page 135
8.2.3 Other considerations regarding the proceeds and payment of interest......Page 138
8.3 Types of transactions......Page 139
8.3.2 Indemnity transactions......Page 140
8.4 Conclusion......Page 144
9.1 The creation of a sustainable and liquid market......Page 146
9.1.1 Creation of common terminology......Page 147
9.1.3 Correlation with other investments in the portfolio......Page 148
9.1.5 Valuation and liquidity......Page 150
9.2.1 Assessment of the underlying risks being securitised......Page 151
9.2.2 Risk assessment of the instrument......Page 153
9.2.3 Pricing and risk-return profile......Page 154
9.3.1 Collateral arrangements......Page 156
9.3.2 Data transparency......Page 157
9.3.4 Modelling rigour......Page 158
10.1.1 Completing the circle......Page 160
10.1.2 ‘Square peg in a round hole?’......Page 161
10.2.2 Nuts and bolts – how the platform works......Page 162
10.2.4 Portfolio analysis......Page 163
10.3.2 How is it done? A bird’s eye view......Page 166
10.4 Conclusion......Page 167
11 The Evolution and Future of Reinsurance Sidecars......Page 170
11.1 A brief history of the brief history of sidecars......Page 171
11.2.1 Basic structure......Page 172
11.2.2 Market-facing sidecar......Page 173
11.2.3 Non-market-facing sidecar......Page 174
11.2.4 Capitalising sidecars......Page 175
11.2.5 How sidecars and catastrophe bonds are different......Page 176
11.3.1 From a cedant/sponsor perspective......Page 177
11.4 Structuring considerations......Page 178
11.5 The outlook for sidecars......Page 179
11.6 Conclusion......Page 180
12.2 Atlas III and IV: Background......Page 182
12.3 Atlas: Main characteristics......Page 184
12.4.3 Overlap......Page 187
12.4.4 Synthetic covers......Page 188
12.6 Conclusion......Page 189
A.1 Definition of events......Page 190
A.2 Extension events......Page 191
13.1 A positive evolution of Swiss Re’s ILS strategy......Page 192
13.3 The first ILS to use a cash reserve account as credit enhancement......Page 193
13.4 Innovation leads to more efficient protection......Page 194
PART II LIFE SECURITISATION......Page 196
14 General Features of Life Insurance-Linked Securitisation......Page 198
14.1.1 Mutual life offices......Page 199
14.1.2 Proprietary life offices......Page 200
14.1.4 Principal risks associated with life insurance business......Page 202
14.1.5 Principal product types and associated risks......Page 205
14.2.1 Sponsor......Page 206
14.2.4 External professional advisers......Page 208
14.2.7 Liquidity providers......Page 210
14.3 Process......Page 211
15 Cedants’ Perspectives on Life Securitisation......Page 218
15A.1 Why securitise?......Page 220
15A.2 Life ILS can be complex......Page 223
15A.3 Outlook for life ILS......Page 227
15B.1 Key considerations......Page 228
15B.2 Examples of securitisation opportunities......Page 231
15B.3 Differences between securitisation and reinsurance......Page 234
16.1 Fitch’s approach to the rating process......Page 236
16.2.1 Risk modelling......Page 237
16.2.2 Ratings benchmarks......Page 238
16.2.4 Surveillance......Page 239
16.3 Zest: a VIF case study......Page 240
References......Page 241
17.1 Modelling of a catastrophic mortality transaction......Page 242
17.2 Modelling of a VIF transaction......Page 245
18.1.1 Some background on monetisation......Page 248
18.1.2 The market drivers of monetisation......Page 249
18.1.4 Some transaction structures......Page 250
18.2.4 Warranties......Page 251
18.2.6 Recharacterisation risk......Page 252
18.3.1 A classical VIF structure: Gracechurch......Page 254
18.3.2 A private but reported transaction: Zest......Page 255
18.4 Outlook......Page 256
19.1.1 The role of the monolines......Page 258
19.1.2 Understanding the risk......Page 259
19.1.3 Correlation with other investments......Page 263
19.1.4 Relative value......Page 265
19.2.1 Risk assessment of the instrument......Page 266
19.2.2 Pricing and risk-return profile......Page 269
19.3 Market evolution: the investor perspective......Page 271
20.1 Mortality and longevity risk......Page 274
20.2.1 Potential sources of longevity risk for securitisation......Page 275
20.2.2 Demand for longevity risk......Page 276
20.3.1 Isolating longevity risk......Page 277
20.3.2 Analysis of longevity risks......Page 278
20.3.3 Longevity risk – legal explanation......Page 279
20.3.4 Examples and legal aspects of transaction structures......Page 281
20.4.1 Model risk......Page 284
20.4.3 Pricing......Page 287
21 Longevity Risk Transfer: Indices and Capital Market Solutions......Page 290
21.1 The nature of longevity risk......Page 291
21.2.1 Hedgers......Page 292
21.2.3 Intermediaries......Page 294
21.3.1 Longevity indices......Page 295
21.4.1 Longevity bond......Page 297
21.4.3 q-forward......Page 298
21.4.4 Survivor forward......Page 300
21.4.5 Instruments and liquidity......Page 301
21.5.2 Standardised index-based longevity hedge......Page 302
21.6 Case study: customised longevity hedge......Page 303
21.7 Implementing a standardised index-based longevity hedge......Page 304
21.7.1 Liability sensitivity and hedge calibration......Page 305
21.7.2 Hedge effectiveness analysis......Page 307
References......Page 309
22.1 Catastrophic pandemic risk......Page 312
22.2 Considered risk transfer tools......Page 313
22.3 Detailed structure......Page 314
22.4.2 Index construction......Page 316
22.7 Next steps......Page 317
Reference......Page 320
23 Case Study: Some Embedded Value and XXX Securitisations......Page 322
23.1 Embedded value securitisation – Avondale S.A.......Page 324
23.2 XXX securitisation......Page 328
PART III TAX AND REGULATORY CONSIDERATIONS......Page 334
24 The UK Taxation Treatment of Insurance-Linked Securities......Page 336
24.1.2 Implementation of the ISPV framework in the UK......Page 337
24.1.3 UK tax treatment of ISPVs......Page 339
24.2 Non-UK insurance special purpose vehicles......Page 344
24.2.1 Tax residence status of the issuer......Page 345
24.2.2 Tax residence status of the issuer’s agents......Page 346
24.2.3 Location and management of the issuer’s assets......Page 347
24.3 Indirect taxes and withholding of income tax......Page 349
Further reading......Page 350
25 The US Federal Income Taxation Treatment of Insurance-Linked Securities......Page 352
25.1.1 Overview......Page 353
25.1.2 Trade or business in the United States......Page 354
25.1.3 Procedures followed by catastrophe bond issuers to avoid substantive business activities in the United States......Page 355
25.2.1 Overview......Page 357
25.2.2 Descriptions of insurance-linked instruments written on standard ISDA forms......Page 359
25.2.3 Federal income tax definition of notional principal contracts......Page 360
25.2.5 The Bank of America case (income not clearly described within any other generally recognised category)......Page 363
25.3.1 US investors......Page 364
25.3.2 Timing and character of income and gain of the issuer with respect to the permitted investments, the total return swap and the insurance-linked instrument......Page 367
Reference......Page 368
26.1.1 Solvency capital......Page 370
26.1.2 Recognition of sponsors’ claims against SPV as eligible assets......Page 371
26.2.1 Overview......Page 372
26.2.2 Requirement to maintain a solvency margin......Page 373
26.2.3 Structuring ILS under EU Directives to enhance solvency margins......Page 377
26.3 Solvency II......Page 380
26.3.2 Determination of technical provisions......Page 382
26.3.3 Solvency capital requirement......Page 383
26.3.4 Minimum capital requirement......Page 387
26.3.5 Own funds......Page 388
26.3.6 Investments......Page 389
A.2 Calculation of the non-life underwriting risk module......Page 390
A.4 Calculation of the market risk module......Page 391
Index......Page 392