BEYOND CONVERGENCE, TOWARDS INTEGRATION - The next … Lane... · BEYOND CONVERGENCE, TOWARDS...

BEYOND CONVERGENCE,TOWARDS INTEGRATION

- The next steps for the ILS Market

Morton Lane Ph.D. President , Lane Financial LLCSept 22nd 2008 Sydney

LANE FINANCIAL L.L.C.LANE FINANCIAL L.L.C.

1

OUTLINE Beyond Convergence, towards Integration

Observations on the ILS Market - Motivation and Growth, - Price Trends, and Historic Returns

Investor Information on ILS- Remodeling and Scenarios/Event Sets

Ri k d E i th I d P tf li- Risk and Exposures in the Index Portfolio- Benefits, and Problems, with Progress

Optimizing with the Scenario SetsOptimizing with the Scenario Sets - ILS Portfolio Management subject to a Risk Profile- Adding OLWs or Traditional Treaties to the Portfolio- Other Applications


2

Other Applications

Concluding Remarks

175

Return Indices for

150

Return Indices for S&P 500and

Lane Financial Insurance Return Index

125

100

S&P500 ILS

50

75


3

50

Jan‐02 Jan‐03 Jan‐04 Jan‐05 Jan‐06 Jan‐07 Jan‐08

8.00%

10.00%

Monthly Returns from the S&P 500vs.

i i l d

4.00%

6.00%

Lane Financial Insurance Return Index

ILS

0.00%

2.00%

vs.S&P 500

Correlation

‐4.00%

‐2.00%

Correlation

3% - 15%

‐8.00%

‐6.00%

S&P 500 "ILS TOTAL RETURN


4

‐10.00%

S&P 500 ILS TOTAL RETURN

$7,451

$7,000

$8,000

Total ILS Iss ance

$5,605$6,000

$7,000Total ILS Issuance Q1 to Q1

1998 to Q2/2008Red: Cat Bonds; Stripe: Life ILS

* "Sidecar" transactions and certain Life securitizations not included here could add a further estimated

$3 277

$4,000

$5,000included here, could add a further estimated

$4 billion to the combined 2006 and 3/2007 totals.

$1,894 $1,803

$3,277

$2,000

$3,000

$886

$1,367 $1,219 $1,126$827 $832

$0

$1,000


5

$01998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

175%

200%

350

400

U.S. CATASTROPHE REINSURANCE PRICE INDICES (Source 1984-2001: PARAGON, a former subsidiary of the Benfield Group

Source 2001-2007 Q1 : LFC averages based on Secondary Cat Bond prices and ILW Prices)

125%

150%

250

300

x pl

us

he P

rices

P t 75%

100%

150

200

ar C

hang

es i

n In

dex

ed C

hang

es i

n bl

ue

Inde

x of

Cat

astro

p h

PostAndrew

Post 9/11

PostKatrina

25%

50%

75%

50

100

150

% Y

ear

to Y

eade

-tren

de

Para

gon

and

LFC

0%

25%

0

50


6

-25%-501984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Q12008

175.0

200.060%

Synthetic Price Index

125.0

150.045%

es

Synthetic Price Indexand Q/Q % Changes

Average of Cat ILS, ILWs and Constant EL *

(*i.e. ArborI/SIIA/SHDVI series)

75.0

100.030%

ex o

f Pri

ces

Q/Q

Cha

nge

in P

rice

25.0

50.015%

Inde

Per

cent

age

Q

-25.0

0.00%


-50.0-15%

$180

Current (Q2, 2008)Total Value of $100 Index Investment in

$167.42[CAGR8.25%]

$160

nt

Cat Bonds commencing 1/1/02

Total Return -(Insurance Return + Floating

Return i.e. LIBOR or EURIBOR) $136.94

[CAGR4 96%]

$140

ue o

f Inv

estm

en

Insurance Return

4.96%]$120

Dol

lar V

al

$100 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Total Return Insurance Return


$80 Time

High Total Return

2.0%

1.0%

hly)

0.0%Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

e R

etur

ns (M

onth

MonthlyAll CAT ILS-1.0%

Perc

enta

ge Monthly All CAT ILS Total Return Performance

2002 - Q2, 2007Total Return Avg 0.664% Std Dev 0.553%Insurance Return Avg 0.405% Std Dev 0.523%

Total Return

Insurance Return

-2.0%Annual Equivalents

Avg 7.972% Std Dev 1.916%Avg 4.862% Std Dev 1.811% Floating i.e. LIBOR


-3.0%

High Sharpe Ratio

30.0%

40.0%

Annual Average Return on Equity for Selected Reinsurers, Ordered by Average ROAE, 2002 to 2007

Ren Re

10.0%

20.0%Average

CMRe Arch

‐10.0%

0.0%

2006 2007 2003 2002 2004 2005

Ren Re

‐30.0%

‐20.0%Average IPC

RNR PRE

EVEREST ACE

XL ARCH

XL

‐50.0%

‐40.0%ASPEN AWAC

AXIS ENDURANCE

LANCASHIRE MAX RE

MONTPELIER PLATINUM

WHT MTN CMRe

IPC

Montpelier


10

‐60.0%

Leveraged vs. Unleveraged Historical Profiles







11

Other Applications

Concluding Remarks

Issue MangroveClass B

Valais Re Class C

Residential Re Class 2

SponsorHomewise InsuranceGlacier, Swiss

Flagstone USAA

Modeler AIR RMS AIR

PFL(%) 6.62 / 7.62 4.50 4.32 / 5.08

EL(%) 3.70 / 4.30 3.52 2.85 / 3.32

PLL(%) 2.44 / 2.81 2.50 1.84 / 2.17

Spread (%) L+ 13.25 L+14.50 L+11.50

EL Multiple 3.1 4.1 3.5


12

Coverages(All are occurrence

based)Florida

Hurricane

N. AmericanHurricane, EQJap Wind, EQ

Gulf, E. Coast HW Hurricane

US EQ

Questions

All are indemnity ILS, are all issuers equally good underwriters? Are all equally well aligned with investor interest?

Is 2% by RMS the exact equivalent of 2% by AIR? (Or EQECAT). Ditto PFL, PLL?

Would a repeat of Andrew (92) exhaust or attach all of theWould a repeat of Andrew (92) exhaust or attach all of the deals to the same extent?

How do various scenarios accumulate? Amongst each otherHow do various scenarios accumulate? Amongst each other, and with traditional treaties and ILWs?

What if all deals were evaluated on the same basis?


13

Re-Modeled Scenario Sets

AIR, RMS and EQECAT all are now offering versions ofscenario sets

In what follows, AIR has provided 10,000 annual scenarios,based on a 35,000+ event set

An Example of Scenario Set Benefitsp

A Prospective View of the Market Index Portfolio


14


15


16


17

ILS Portfolio Annual Risk and Return Statistics"Insurance" Only LIBOR at 3.25% LIBOR at 5.00%

Portfolio Weighted average Coupon Spread 6.0%Portfoilo Expected Loss 1.6%Expected Returns 4.4% 7.7% 9.4%Standard Deviation 4.1%

Sharpe Ratio 1.08

Probability of First Insurance $ Loss 51 0% 51 0% 51 0%Probability of First Insurance $ Loss 51.0% 51.0% 51.0%Probability of Exceeding Expected Return 76.6%Probability of Positive Total Return 91.7% 95.1% 95.9%

"Insurance" Returns VAR Level 90.00% 95.00% 99.00% 99.60%VaR 0.88% -3.12% -16.67% -20.14%

TVaR -11.64% -16.60% -27.23% -32.09%


18

Peril Share of Expected LossPortfolio Exp Loss 1.59%

US EQ17%

JPN EQ6%

JPN Wind5%

Other4%

US Wind42%

EUR EQ3%

EUR Wind23%


12.0%

Portfolio Diversification ‐Where Losses Come From

8.0%

10.0%Where Losses Come From

The chance of Principal losses exceeding 5% is over 10%, see bar. The peril source of losses at that level is shown as the bar breakdown.

6.0%

Losses from Combined EventsOtherJPN WindJPN EQ

4.0%

EUR WindEUR EQUS EQUS Wind

0 0%

2.0%


0.0%

5% Loss Level 10% Loss Level 15% Loss Level 20% Loss Level 25% Loss Level 50% Loss Level

Selected Sample Transactions Re-Modeled By AIR.

DEAL AJAX Redwood X Class B Akibare A Foundation

Re D

Residential Re 2007 Class

3


5 US Wind US US Wind US US Wind US Principal Perils US Quake US Quake Japan Wind US Wind US

QuakeUS Wind US

QuakeUS Wind US

QuakeOriginal OC Modeler EqeCat EqeCat RMS RMS AIR AIR

Q1 Secondary Mkt Yield 5.48% 3.18% 2.62% 3.55% 10.75% 6.47%

Re-Modeled EL 1.96% 0.65% 3.59% 2.44% 2.49% 1.03%

Stand Alone Risk StatisticsStd Dev 13.69% 7.67% 18.43% 14.85% 14.02% 9.76%VaR 99 100 00% 0 00% 99 56% 100 00% 100 00% 55 22%VaR 99 100.00% 0.00% 99.56% 100.00% 100.00% 55.22%TVaR 99 100.00% 64.50% 99.56% 100.00% 100.00% 96.53%

Data Courtesy of AIR, from Early AIR Model Versions.


21Other Benefits – More Risk Measures

Some surprises (perhaps)

R d l d EL’ d t l l i i l PPM EL’Re-modeled EL’s do not always equal original PPM EL’s

Not all ILS appear to be re-model-able based on PPM datapp

Notwithstanding, it is extremely valuable to have all ILS on the same basisthe same basis


22

Selected Sample Transactions Re Modeled By AIRSelected Sample Transactions Re-Modeled By AIR.

DEAL AJAX Redwood X Class B Akibare A Foundation

Re D


3


5

Principal Perils US Quake US Quake Japan Wind US Wind US Q k

US Wind US Q k

US Wind US Q k Principal Perils US Quake US Quake Japan Wind Quake Quake Quake

Original OC Modeler EqeCat EqeCat RMS RMS AIR AIR

Issue Spread 6.25% 3.60% 2.95% 7.25% 12.25% 7.75%Q1 S d Mk Yi ld 48% 3 18% 2 62% 3 % 10 % 6 4 %Q1 Secondary Mkt Yield 5.48% 3.18% 2.62% 3.55% 10.75% 6.47%

OC EL 1.94% 0.68% 1.04% 1.21% 2.74% 0.77%Re-Modeled EL 1.96% 0.65% 3.59% 2.44% 2.49% 1.03%AIR Conservatism bps 2 3 255 123 25 26

Data Courtesy of AIR, from Early AIR Model Versions.


23

Showing Increasing Capital Requirements for Incremental Amounts of Different Peril ILWs

CMRe 08Q1 Cal Quake $20 Billion

ILW Premium 6.50%Total Limit or Face Value of ILS Securities $12,132,404,584 + $250,000,000

Original Portfolio Expected Loss 2.18% 2.13%Re-modeled Portfolio Expected Loss 2.33% 2.33%

Standard Deviation $599,481,642 2.92%

Portfolio TVaR99 $3,708,564,018 1.21%

ILW Expected Loss 2.41%

Expected Return on Capital Standards, Including Premium in the CapitalPortfolio TVaR99 17.90% 18.07%

Limit 4.29% 4.28%


24

Note, all ILWs are added individually in exposure amounts of $250,000,000. All ILWs have an EL of 2.5% + or - 0.5%

Comparative Statics


CMRe 08Q1US All Natural

Perils $70 Billion

ILW Premium 8.50%Total Limit or Face Value of ILS Securities $12 132 404 584 + $250 000 000Total Limit or Face Value of ILS Securities $12,132,404,584 + $250,000,000


Standard Deviation $599,481,642 4.29%

Portfolio TVaR99 $3,708,564,018 5.93%



Limit 4.29% 4.33%


25


Comparative Statics


CMRe 08Q1 Japan Quake $12.5 Billion

ILW Premium 6.50%Total Limit or Face Value of ILS Securities $12 132 404 584 + $250 000 000Total Limit or Face Value of ILS Securities $12,132,404,584 + $250,000,000


Standard Deviation $599,481,642 1.15%, ,

Portfolio TVaR99 $3,708,564,018 0.20%



Limit 4.29% 4.28%


26


Comparative Statics







27

Other Applications

Concluding Remarks

ReA/L RisKontroller™

Combining ReA/L RisKontroller and the AIR Worldwide Catastrophe Scenario Set to Optimize ILS Portfolios

ReAL1 RisKontroller Optimizer – joint venture ofReAL RisKontroller Optimizer joint venture of Lane Financial LLC and RisKontroll Group GhmB

Maximize expected return of 10,000 year scenario set

Choose among all outstanding ILS

Allow writing or ceding of OLWsg g

Scenario set available for ILS and OLWs or Traditional Treaties

Construct a portfolio such that it satisfies a multi layered


28

Construct a portfolio such that it satisfies a multi-layeredset of CVaR (a.k.a. TVaR) or VaR constraints

1 ReAL is Re-insurance Asset Liability Optimizer

Comment – AIR Worldwide or any re-modeler may have less information on those ILS that it did not originally model (Ditto RMS or Eqecat).

Re-modelers therefore tend to be more conservative in their loss estimates on remodeled deals (i e higher than PPMloss estimates on remodeled deals (i.e. higher than PPM provided expected losses) but not always so.

ReA/L RisKontroller can be used with scenario sets from RMS E i h d i d bi i fRMS or Eqecat, or with a custom designed or combination of scenario sets.


29

Sample Problem Maximize Expected Return on Capital (over the 10,000 year scenario set)

Subject to,

a) for the worst 4% of scenarios (400), the expected loss should not exceed 10%) ( ), p(i.e. 96% TVAR <= 10% Loss)

b) for the worst 1% of scenarios (100), the expected loss should not exceed 20%(i.e. 99% TVaR <= 20% loss)

c) for the worst 0.1% of scenarios (10), the expected loss should not exceed 40%(i.e. 99.9% TVaR <= 40% loss)

d) Limits on purchasing and selling activity of ILS, writing or retroceding of ILWs

e) Financing restrictions if any. . . . . .


30

ThThe Opportunity Set


31

20%

0%

10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Retu

E d P b bilit

‐10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%rn

on

Exceedence Probability

Portfolio Improvement Strategieswith/without ILWs and Shorting Possibilities

‐30%

‐20% Capit

with/without ILWs and Shorting Possibilities

‐40%

a

l

Initial Portfolio


32

‐50%(Note, some optimization restrictions are lifted for graphical effect)

20%

0%

10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Retu

E d P b bilit

‐10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%rn

on



‐30%

‐20% Capit


‐40%

a

l

Initial Portfolio ILS Only


33

‐50%

y

(Note, some optimization restrictions are lifted for graphical effect)

20%

0%

10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Retu

E d P b bilit

‐10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%rn

on



(Note, some optimization restrictions are lifted for graphical effect)

‐30%

‐20% Capit


Initial Portfolio Rearranging ILS ILS and ILW

Buy & Sell Write/Cede ILWsExpected Profit 5.93% 10.16% 12.03%Marginal Return 5 81% 4 56%

‐40%

a

l

Initial Portfolio ILS Only ILW Long/Short

on Capital 5.81% 4.56%

90.00% 2.77% 3.16% 5.78%99.50% -2.20% -2.79% -0.54%99.00% -24.23% -12.14% -13.05%99.60% -29.23% -22.50% -19.59%

Max -43.23% -37.60% -45.25%


34

‐50%

y g/

(Some optimization restrictions are lifted for graphical effect)

ASpecificExample


1% of every ILS Double Initial H ldi d/ ll

Double Initial H ldi d/ Sh t

Double initial H ldi d/ h t

BASE CASE CASE II CASE III CASE IV

Comparison of Four O ti i i S l ti

Expected Ending Income Statement (Millions $US)I

Holdings and/or sell initial Holdings

Holdings and/or Short 1%

Holdings and/or short 1%, and/or Write

ILWs

Optimizing Solutions

Income Written Premium $4.62 $6.48 $7.13 $8.96 Ceded Premium $0.00 $0.00 -$0.75 -$0.86 Net written Premium $4.62 $6.48 $6.38 $8.09 Investment Income $0.00 $0.00 $0.00 $0.00

$4 62 $6 48 $6 38 $8 09 $4.62 $6.48 $6.38 $8.09 Expenses Expected Losses -$1.18 -$1.50 -$1.65 -$2.19 Expected Recoveries $0.00 $0.00 $0.64 $0.67

Expected Net Losses -$1.18 -$1.50 -$1.01 -$1.52 Expected Net Losses $1.18 $1.50 $1.01 $1.52 Brokerage & Acquisition expense $0.00 $0.00 $0.00 $0.00 General & Administrative $0.00 $0.00 $0.00 $0.00 Expected Profit $3.44 $4.98 $5.37 $6.58


Expected Rate on Equity

3.44% 4.98% 5.37% 6.58%

1% of every ILS Double Initial Double Initial Double initial

BASE CASE CASE II CASE III CASE IV

Comparison of Four

Exposure ReportTotal Net Exposure 48 2340 44 45 26 51 90

Holdings and/or sell initial Holdings

Holdings and/or Short 1%

Holdings and/or short 1%, and/or Write

ILWs

Optimizing Solutions

Total Net ExposureNet Premium to Net CoverLeverage: Exposure/Capital Underwriting ReportPremiums Written

40.44%

48.2313.22%

40.4411.42%

4.62

45.2614.32%45.26%

6.48

48.23%

7.13

51.9015.59%51.90%

8.96Premiums CededExpected LossesExpected RecoveriesExpected Underwriting Profit

0.00-1.180.00

0.00-1.50

5.370.00

3.44 4.98

-0.86-2.190.67

-0.75-1.650.64

6.58

Portfolio Loss Ratios Net Written Premiums Expected Net Losses Expected Net Loss Ratio

4.621.18

25.59%

6.481.50

23.21% 18.74%

6.381.01

15.81%

8.091.52


Double Initial Holdings and/or

Short 1%

Double Initial Holdings and/or short 1%, and/or

Write ILWsDetails of Solutions in

Four Optimization

Base Case 1% of every ILS

Double Initial Holdings and/or sell

Initial Holdings

Written Premium

(Mil)

Ceded Premium

(Mil)

Written Premium

(Mil)

Ceded Premium

(Mil)

Written Premium

(Mil)

Ceded Premium

(Mil)

Written Premium

(Mil)

Ceded Premium

(Mil)Aiolos $0.0886 $0.0886 $0.0886 $0.0886 AJAX $0.0548 $0.0234

Four Optimization Runs

Akibare A $0.0235 $0.0235Akibare B $0.0082 $0.0082Australis $0.0294 $0.0588 $0.0588 $0.0588 Blue Fin Ltd A $0.1176 $0.1176Blue Fin Ltd B $0.0295 $0.0295Calabash A-1 $0.0590 $0.0571Calabash Re II A 1 $0 0681 $0 1362 $0 1362 $0 1362Calabash Re II A-1 $0.0681 $0.1362 $0.1362 $0.1362Calabash Re II D-1 $0.0279 $0.0557 $0.0557 $0.0557 Calabash Re II E-1 $0.0881 $0.0000 $0.1762 $0.1012 Carillon 1 A-1 $0.0464 $0.0928 $0.0928 $0.0928 Carillon 2 $0.2052 $0.4104 $0.4104 $0.4104 Cascadia $0.0876 $0.1510 $0.1752 $0.1752 Cascadia II $0.0918 $0.1836 $0.1836 $0.1836 CAT-Mex A $0.0510 $0.1020 $0.1020 $0.1020CAT-Mex B $0.0032 $0.0063 $0.0063 $0.0063 Champlain A $0.0769 $0.0163 $0.0641 Champlain B $0.0203 $0.0405 $0.0405 $0.0405 East Lane Re A $0.0740 $0.0901 $0.1480 $0.1480 East Lane Re B $0.0731 $0.1462 $0.1462 $0.1462 East Lane II A $0 0467 $0 0240 $0 0933


East Lane II A $0.0467 $0.0240 $0.0933East Lane II B $0.0505 $0.1011 $0.1011 $0.1011 East Lane II C $0.0795 $0.0795 $0.0795Eurus $0.0592 $0.1184 $0.1184 $0.1184 Fhu-Jin B $0.0595 $0.1190 $0.1190 $0.1190 Foundation Re A $0.1291 $0.0477 $0.1291

Double Initial Holdings and/or

Short 1%

Double Initial Holdings and/or short 1%, and/or

Write ILWsDetails of Solutions in

Base Case 1% of every ILS

Double Initial Holdings and/or sell

Initial Holdings

Successor Japan Quake Class A- $0.0309 $0.0619 $0.0619 $0.0619Successor Japan Quake Class B- $0.0105 $0.0209 $0.0209 $0.0209 Successor Japan Quake Class C- $0.0498 $0.0996 $0.0996 $0.0996

Written Premium

(Mil)

Ceded Premium

(Mil)

Written Premium

(Mil)

Ceded Premium

(Mil)

Written Premium

(Mil)

Ceded Premium

(Mil)

Written Premium

(Mil)

Ceded Premium

(Mil)

Write ILWsFour Optimization Runs

Successor Japan Quake Class C $0.0498 $0.0996 $0.0996 $0.0996Successor Euro Wind Class A-I $0.0175 $0.0010 $0.0350 $0.0350 Successor Euro Wind Class A-III $0.0308 $0.0616 $0.0616 $0.0616 Successor Euro Wind Class C-III $0.0080 $0.0160 $0.0160 $0.0160 Successor I Class B-II $0.0708 $0.1416 $0.1416 $0.1416 Successor II Class C-III $0.0249 Successor II Class E-III $0.1248 $0.2497 $0.2497 $0.2497 Willow Re $0.1035 $0.0682 $0.0363ILW California Quake 10B $0 1100ILW California Quake 10B $0.1100ILW California Quake 12.5B $0.9500 ILW California Quake 15B ILW California Quake 20B ILW California Quake 25B ILW California Quake 30B ILW California Quake 40B ILW California Quake 50B $0.0350

$ILW California Quake 5B $0.1575ILW California Quake 60B $0.0300 ILW California Quake 70B $0.0275 ILW Florida Wind 10B $0.2275 ILW Florida Wind 12.5B $0.1950 ILW Florida Wind 15B $0.1750 ILW Florida Wind 20B $0.1450 ILW Florida Wind 25B $0.1275


$ILW Florida Wind 30B ILW Florida Wind 40B ILW Florida Wind 50B ILW Florida Wind 60B ILW Florida Wind 70B

The Optimal Solution Reports,a) The ILS in the optimal portfolio

b) The set of buy sell transactions to effect the optimum

c) The rank ordering of the deals to buy (B-T-W) and deals to sell

d) Marginal prices at which non-optimal deals can be bought or sold

e) Sets of Risk-adjusted pricese) Sets of Risk adjusted prices

f) Reports showing risk profile, marginal return on capital

) I li d P b bili ig) Implied Probabilities

h) Problematic scenario ranking


40

i) Expected Balance sheets, Income Statements

j) Expected Underwriting and leverage reports







41

Other Applications

Concluding Remarks

Implied Probabilities – Worst 2% of scenarios

I li it b bilit i hti f li it f i tImplicit probability weighting of explicit preference requirements


42

Other Applications of OptimizationPortfolio Selection

Traditional Reinsurers’ Portfolio (including ILS, ILWs)

Simultaneously Ceding and Pricing Retrocessional cover

Replication strategies Best ILWs to represent particular ILS

Mi i i i b i i kMinimizing basis risk

Capital StructureOptimal capital structure for Insurance CDO’sp p

Capital allocation Rules

Insurance


43

InsuranceInsurance company allocation of sales efforts

END

Contact

[email protected]

[email protected]

Web site

www.LaneFinancialLLC.com


44

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