CONFERENCE ON CATASTROPHIC RISKS AND ...Powerpoint presentation This document is circulated for...

DIRECTORATE FOR FINANCIAL AND ENTERPRISE AFFAIRS

CONFERENCE ON CATASTROPHIC RISKS AND INSURANCE

22-23 November 2004

THE USE OF RISK LINKED SECURITIES TO MANAGE CATASTROPHIC RISKS

Christian Mumenthaler (Swiss Re)

Powerpoint presentation

This document is circulated for Session 2 of the Conference on Catastrophic Risks and Insurance, to be held on 22-23 November 2004 at the OECD Headquarters, 2 rue André Pascal, 75016 Paris, starting at 9:00 a.m.

For further information on this conference, please contact Cécile Vignial, Financial Markets Division ([email protected]), or Yosuke Kawakami or Morven Alexander, Outreach Unit for Financial Sector Reform ([email protected] or [email protected])

The use of risk linked securities to manage catastrophic risks

Dr. Christian Mumenthaler

Head of Group Retro & Syndication, Swiss Re

OECD Conference

22 November 2004

Agenda

Nat cat risks: A success story

Terrorism: An open issue

Insurance and reinsurance industry have lost 20% of their equity

0

100

200

300

400

500

600

700

800

Capital, end of2000

Estimatedcapital

destroyed

Capital raised Estimatedcurrent capital

Global P&C industry capital (USD bn)

Source: Swiss Re Economic Research & Consulting

WTC losses

Equity market downturn

Dr. Christian MumenthalerOECD Conference22 Nov 2004

Most reinsurers have been downgraded

Swis

s R

e

Mun

ich

Re

Ber

kshi

re H

atha

way

Empl

oyer

s R

e

Han

nove

r Re

Ger

ling

Glo

bal R

e

Lloy

d’s

Alli

anz

Re

SCO

R

AXA

Re

Con

veriu

m(1

)

S&P rating

11 Sept ‘01

8 Nov ‘04


AAA

AA+

AA

AA-

A+

A

A-

BBB+ and less (1) Since Dec ‘01

Five peak risks in the world of P&C reinsurance

Peak risk: Geographical zone with

- high risk of natural hazards (eg earthquakes)

- high density of insured values (eg buildings)Dr. Christian MumenthalerOECD Conference22 Nov 2004

Increasing value concentration(Hurricanes Atlantic)

Projected population change1994-2015

Source: National Oceanic and Atmospheric Administration (NOAA).

Hurricanes recorded in the US in the last 110 years

Source: Swiss Re’s Nat Cat team


3020100

Consequence: Building a well-balanced book of business is difficult


USA (EQ + TC) (1)

WS Europe

EQ Japan

TC Japan

EQ Australia

EQ Canada

EQ Italy

EQ Columbia

EQ Israel

EQ Mexico

EQ Portugal

EQ South Africa

World wide coverage (CHF bn)

Legend: EQ = Earthquakes, WS = Windstorms, TC = Tropical cyclone

(1) No separation available between EQ and TC risks in the US market

Ideal level reinsurance would take for optimal diversification

Peak risks would ideally be ceded to capital markets, which are better able to diversify these risks

Worldwide cover bought in R/I market per peril in 2003

Capital markets are an answer for Swiss Re

Transformed by Swiss Re and/or underwritten by Swiss Re Capital Markets (lead or co-lead)Sponsored by Swiss Re and underwritten through Swiss Re Capital Markets (sole)


1997 1998 1999 2000 2001 2002 2003

2 132

714 724825

1 122967 990

Trinity Re I

Res Re I

Pacific Re

SR EarthquakeTrinity 99

Parametric

Mosaic Re

Res Re II

Seismic

Atlas Re

Alpha W ind

Res Re 2000

NeHi

Med RePrime Cal Quake

Eurowind

PrimeHurricane

Mosaic Re II

Domestic

Halyard Re

Concentric

Res Re III

Juno Re

Namazu

Gold Eagle I

W estern

SR W ind A2

SR W ind A1

Gold Eagle

Trinom

Res Re 20 01

Atlas Re II

Redwood I

Redwood II

St AgathaRes Re 20 02

Fujiyama

Studio Re

PIONEER

Phoenix Quake

Phoenix QuakeWind

Arbor

USAA Res Re 2003

Redwood IV

Vita Capital

Formosa

Pylon BPylon A

Redwood III

PIONEERPhoenix QW II

New issue volume of insurance linked securities (in USD millions)

Oak CapitalGi Capital

Sequoia CapitalHelix 04

Res Re 2004

Arbor I

580

2004to date

Securitization prices have fallenabout 20% since mid-2002


Secondary market spreads (as of 30 September 2004)

Hurricane Ivan

Terrorism: An open issue


New stage ahead?

Insurance

Reinsurance

?

1666 fire in London, growing importance of sea-borne trade leads to creation of first insurers

1680 1840

Catastrophic fires in Hamburg and Glarus lead to creation of first reinsurers

2002

Terrorism and other new risks make the creation of new capacity sources inevitable

IndustrializationConcentration of population in urban centersValue concentration

GlobalizationInterconnectivity leads to higher system sensitivityNew risks


Terrorism:Whence the threat today

After Afghanistan, Iraq: al-Qaida weakened as operational network, but strengthened as source of inspiration for radical Islamists (Bin Laden as ‘hero’)

Terrorist cells increasingly operate independently from al-Qaida. Presence estimated in 60 countries

OECD countries/ US still ‘targets of preference’, but more difficult to penetrate with tightened security. al-Qaida attacks more likely in countries with less security resources (M. East, SE Asia)

9/11 as ‘benchmark’ for indiscriminate use of violence by any terrorists (al-Qaida and others) -> escalating terror (eg Beslan)

Seeking to acquire weapons of mass destruction (nuclear, chemical, bio)

Terror attack fatalities 2002-04 by group

0

200

400

600

800

1000

2002 2003 2004 TD

OthersHamas/ IsraelChechensQaida & allies

Terror attack fatalities 2002-04 by location

OECDRussiaM.East&N.AfricaE.&.S.AsiaOthers


Insurability criteria

Assessibility: loss probability and severity must be quantifiable

Randomness: time of occurrence must be unpredictable, occurrence itself must be independent of the will of the insured

Mutuality: numerous exposed parties must join together to form a risk community, to share and diversify the risk

Economic feasibility: Private insurers must be able to charge a premium which is commensurate with the risk


?

?

Yes

The challenge: Is new terrorism risk insurable?

?major issue

for securitization


How much would you ask for insuring these objects?

Sears towers,

Chicago

Swiss Re building

Zurich

Even without model, there is a price (although probably a high one) at which you would insure them

Hypothesis:Without model, securitization could work in two areas

Risk

high very low

30%-50% spread for the cover

target: hedge funds

With just 2-3 deals the risk is nearly diversified away

Quick payback over time

1%-2% spread for a risk which is perceived to be close to zero

target: banks, pension funds who want some spread pickup with minimal risk

“If it happens, it’s going to impact the world economy and other portfolios anyway”

attractive unattractive attractive

FIFA deal


Insurance-linked securities have worked very well for Swiss Re with natural catastrophe risks– underlying threats are growing and well understood

– win-win situation given: these risks are eating up a disproportionate amount of capital for reinsurers

– Markets have become more efficient, prices have fallen

Securitizing terrorism risk will be a significant challenge

– underlying risk is not well understood (new and constantly changing risk)

Some potential in the two areas where models might not be essential:

1. Very low risk area (FIFA deal) where investors basically think it is not possible or very remote

2. High risk area where investors would basically “bet” and get a high return


Final remarks

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