sigma no 4/2009 - swiss re · swiss re, sigma no 4/2009 5 ̤ life risk was first transferred to the...

sigmaNo 4/2009 The role of indices in transferring

insurance risks to the capital markets

3 Executive summary

4 Introduction

6 Insurance-linked indices

15 Instruments that transfer insurance risks to the capital markets

25 Benefits and market challenges

34 Market developments and outlook

43 Appendix

Published by:Swiss Reinsurance Company LtdEconomic Research & ConsultingP.O. Box8022 ZurichSwitzerland

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Authors:Astrid FreyTelephone +41 43 285 6269

Dr Milka KirovaTelephone +1 212 317 5639

Dr Christian SchmidtTelephone +41 43 285 2001

Editor:Dr Kurt KarlTelephone: +1 212 317 5564

sigma co-editor:Dr Brian RogersTelephone +41 43 285 2733

Managing editor:Thomas Hess, Head of Economic Research & Consulting, is responsible for the sigma series.

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3Swiss Re, sigma No 4/2009

Indices are becoming increasingly commonplace in insurance and reinsurance.

As in finance, they are used for informational purposes and as an input for financial products and contracts that transfer risk. A typical index-linked contract in (re)insurance links payments to an index that tracks the development of insurance losses or approximates insurance losses by linking the payments to certain outcomes (eg the intensity of an earthquake in a certain region). The focus of this sigma is the use of indices to transfer insurance risks to the capital markets.

In insurance, indices were first introduced to transfer natural catastrophe risks to the capital markets. However, they have also been used to transfer weather- related risks and, more recently, mortality and longevity risks to the capital mar-kets. Index-linked instruments include securitisations, industry loss warranties (ILWs) and a variety of derivative contracts. So far, indices have been most suc-cessfully used with P&C bonds, ILWs and weather derivatives.

(Re)insurers and investors both benefit from the use of indices. Index-linked bonds and derivatives broaden risk transfer markets, offer (re)insurers additional ways to manage risk and capital and provide investors with a diversifying asset class. Index-linked contracts, which can be standardised more easily than in-demnity-based transactions, lessen moral hazard and adverse selection prob-lems in addition to facilitating market liquidity and transparency. For investors, indices are often easier to understand than individual insurance risks. However, index-linked contracts inherently contain basis risk for the sponsor.

Despite the progress that has been achieved with these newer financial instru-ments, the share of insurance risks transferred directly to the capital markets has been low. Moreover, insurance risk transfer markets have remained relatively illiquid. The markets could benefit from the creation of new and improved indi-ces that broaden the product space and reduce basis risk for (re)insurers. More consistent accounting, regulatory and rating agency treatment of index-linked instruments would also promote their wider use.

As investors’ understanding of indices and the risks that determine them im-proves, the market should grow. The financial instruments used to transfer risks to investors should also become simpler and more standardised so that investors better understand all of their features and become more interested in this type of asset.

Index-linked catastrophe bonds, cat derivatives, ILWs, and weather derivatives have strong growth potential and are expected to expand to new geographic markets. Significant untapped opportunities also exist for mortality and longevity index-linked risk transfer, supported by increasing pandemic concerns and the savings and retirement needs of an ageing global population.

The use of indices for insurance risk transfer is increasing in importance.

Index-linked risk transfer is expanding to include other risks besides catastrophe risks.

Index-linked instruments provide many advantages to (re)insurers and investors.

Insurance risk transfer markets are still small and could benefit from new indices, ...

... improved transparency and more standardised instruments.

The growth prospects for index-linked instruments are strong.

Executive summary

Swiss Re, sigma No 4/20094

Introduction

Insurance risk is transferred to the capital markets in different ways. The tradi-tional way is through investment in insurance stocks and bonds. Investors who hold insurance stocks assume the risk that losses could potentially wipe out the equity capital of the company. Bondholders are also exposed to risk, to a lesser extent, in that they could lose the interest coupon or the principal of a bond is-sued by an insurer if the company becomes insolvent. More recent developments in the capital markets include a more direct transfer of specific insurance risks to investors via securitisation and derivative instruments.

A distinction can be made between loss or indemnity-based risk transfer and index-based transactions. In ultimate net loss or indemnity-based transactions, the settlement is directly linked to the loss experience of the company issuing the securities. However, in index-linked transactions, the payment is linked to the value of an independent index, such as an industry loss index, or a parametric index, which is linked to a certain outcome (eg the intensity of earthquake activity or wind speed in a specified region). The importance of index-linked instruments as a capital and risk management tool for (re)insurers and as a diversifying asset class for investors is increasing. This sigma concentrates on index-linked insur-ance transactions. Many of these transactions have two triggers – an indemnity trigger that is conditional upon satisfying an index trigger.

The use of indices in insurance transactions is a relatively recent phenomenon. The development of capital market risk transfer instruments was precipitated by a series of major catastrophes in the early to mid-1990s, which caused a shortage of global reinsurance capacity and subsequently drove up prices. In the wake of Hurricane Andrew in 1992 and the Northridge Earthquake in 1994, premium rates more than doubled, setting into motion industry efforts to find alternative sources of reinsurance capacity. Early efforts were based on transfer-ring catastrophe risks related to hurricanes and earthquakes. Over time, the use of indices was extended to weather-related, satellite, aviation and, more recently, mortality and longevity risks, thus allowing more risks to be transferred directly to the capital markets. Below is an overview of key historical developments.

In the 1980s, industry loss warranties (ILWs) were the first index-based contracts that were traded. They were mainly used as a retrocession tool. Cat-linked futures were introduced in 1992 by the Chicago Board of Trade (CBOT). However, the venture was unsuccessful due to an insufficient number of protection sellers. In the mid-1990s, efforts to transfer nat cat risks to the capital markets via index-based insurance-linked securities (ILS) began. Hannover Re issued the first cat-linked securitisation transaction – a USD 85m cat bond – in 1994. Weather derivatives were also introduced in the mid-1990s. The first major deal took place in 1997 between three US energy companies. The Chicago Mercantile Exchange (CME) started listing weather contracts in 1999. The use of derivatives to hedge weather-related risks expanded beyond energy into the leisure, retail and construction sectors.

The transfer of specific insurance risks directly to capital markets is a growing trend.

The importance of direct risk transfer via index-based instruments has increased.

Industry loss warranties were first introduced in the 1980s; index-based insurance-linked securities and derivatives became popular in the 1990s.


Life risk was first transferred to the capital markets via an index-based extreme mortality securitisation in 2003, when Swiss Re issued the first mortal-ity bond. Other mortality bonds have been marketed successfully since then, but the share of risk transferred to investors is low.An attempt to structure a longevity bond with coupon payments linked to an index of lives was unsuccessful in 2004.The first publicly announced index-based mortality swap was completed in 2008 between J.P. Morgan and SCOR. Subsequently, the first index-based longevity swap was completed between J.P. Morgan and Lucida.

Index-based contracts include cat bonds, over-the-counter cat and weather derivatives, exchange-traded contracts for weather and cat risks, ILWs and mortality/longevity swaps. Standardising index-linked contracts and increasing transparency make it easier for these products/risks to be traded by insurance companies directly or through offsetting transactions with a similar risk profile, facilitating risk transfer and portfolio diversification. Currently, cat bonds, ILWs with standardised documentation, and exchange-traded contracts are the only index-based insurance-linked products that can be effectively traded. There appears to be reasonable liquidity in exchange-traded weather derivatives, in the cat bond market, and in ILWs with standardised documentation. Liquidity in over-the-counter derivatives, exchange-traded cat derivatives and non-stand-ardised ILWs is more limited.

The creation of new and improved indices that both investors and sponsors are comfortable with is important for insurance risk trading markets to become more liquid. A very recent development is the creation of indices that measure the return performance of insurance-linked products (eg Swiss Re’s cat bond indices). These help investors to benchmark performance. In the future, it may become possible to trade on such indices.

The importance of index-based insurance risk transfer will continue to grow as the market evolves. So far, index-linked transactions have been a successful capital management tool and a source of additional (re)insurance capacity. They have also facilitated new product offerings in insurance. As indices and index-linked instruments develop further, they could possibly provide a foundation for trading and pricing of insurance risks. A future benefit of trading index-linked contracts and indices based on such contracts is that the price information of these contracts could in some cases be used for insurance pricing.

This sigma explores the prospects for insurance indices and index-based trad-ing. First, it examines the current use of indices in insurance and provides an overview of the instruments that transfer insurance risks to the capital markets. It then analyses the benefits of index-linked contracts and some of the market challenges. Finally, it provides an assessment of the key market developments and an outlook.

Secondary market trading will develop over time.

New and improved indices may further increase the liquidity of insurance risk trading markets.

Capital market prices of insurance risk instruments can be used for pricing insurance.

Plan of this sigma


Insurance-linked indices

The development of insurance-linked indices is critical for transferring life and P&C risks to the capital markets. The most successful indices used in insurance risk transfer transactions balance the needs of insurers with those of investors. This chapter discusses which indices are currently being used.

Types of indices used in index-linked contracts

In index-linked contracts, payments are triggered or derived in whole or in part from the value of an independent index. Index-linked transactions are based on various types of triggers.

An industry loss index estimates industry claims on the basis of a survey of industry representatives. The survey is conducted by a widely recognised data reporting service, such as Property Claims Services (PCS) in the US. Brokers provide information on aviation industry losses.

In a modelled loss transaction, losses are determined by entering actual physical parameters into an agreed-upon, fixed model when calculating the loss.

A pure parametric trigger is based on the actual reported physical event (eg earthquake magnitude or hurricane wind speed).

A parametric index is a more refined version of the pure parametric trigger using more complicated formulas and more detailed measurements.

In a Modeled Industry Trigger Transaction (“MITT”)1 , industry index weights are set post-event using modelled loss techniques.

While investors prefer to maximise the transparency of the trigger, sponsors would like to minimise the basis risk2. Transparency, however, as shown in the figure below, is often associated with higher basis risk.

1 Developed and patented by Swiss Re.2 Basis risk is the risk that actual losses borne by the buyer of protection will deviate from the payoffs

received under the contract.

Insurance indices for risk transfer need to meet the requirements of insurers and investors.

Indices are distinguished by type of metric…


Man-made-Katastrophen

Naturkatastrophen

Modelledloss

Indemnity

Parametricindex

Industryindex

MITT

Pureparametric

Basis risk to sponsor

Tran

spar

ency

for i

nves

tor

Source: Swiss Re Capital Markets

Indices may also be categorised by the type of risk measured – eg property/casualty (P&C), life risks or financial returns. Until recently, most available insur-ance indices represented natural catastrophe (nat cat) P&C exposures, since most insurance-linked securities were linked to this type of risk. Industry partici-pants are, however, now rapidly extending the set of insurance indices to other risks. For example, longevity indices are developed to help pension funds moni-tor and possibly hedge their risk. A financial performance index measures the performance of an asset class. The Swiss Re Cat Bond Indices (SRCBI), for ex-ample, measure the financial returns of outstanding cat bonds.

Indices are provided by both the private and the public sector. Investment banks, for example, have been actively developing new indices for life insurance risks. Insurance industry-related participants, like PCS or PERILS (Pan-European Risk Insurance Linked Services), and risk management consultants are other impor-tant sources for insurance indices. The public sector also provides insurance in-dices. Some of the recently launched longevity indices are based on population data provided by governments’ statistical offices. In addition, government science agencies provide data for indices – eg ShakeMap (US) for earthquakes and AMeDAS (Japan) for typhoons.

The emergence of the insurance-linked securities (ILS) market, and the corre-sponding need to provide price and return information to investors, led to the demand for indices that measure the performance of the traded insurance market. The Swiss Re Cat Bond Indices (SRCBI), launched in 2007, aim to meet this demand and to increase the transparency of cat bond returns, with the possibility that investors could trade these indices in the future. The calculation, undertaken by S&P Custom Indices, is on a market value basis, with each cat bond in the index weighted by the outstanding market value3.

3 The Swiss Re Cat Bond Indices contain sub-indices for single-peril US wind cat bonds, for single peril California earthquake cat bonds and for “BB” or equivalent cat bonds. Price return, coupon return and total return indices are distributed. The Swiss Re Cat Bond Indices are calculated based on bid pricing indications provided by Swiss Re Capital Markets.

Figure 1: The transparency and basis risk for various types of triggers

… and by type of risk or return measured.

Insurance indices are provided by private and public sources.

Performance indices for ILS investors are rare.



What criteria must an index fulfil for it to be suitable for transferring insurance risks to the financial market?

An effective index is an objectively defined parameter that can be rapidly quan-tified following an insurable event.

In order for it to be accepted by the relevant financial market players, an index needs to satisfy different requirements:

The index must be transparent, ie it has to be observable, quantifiable and clearly defined.The index and the contract related to it should be reasonably simple in order for investors to be able to judge the risk/benefit of assuming the risk.The values of the index should be published without significant delay so that financial transactions can be processed speedily.The index should be accurate and reliable, and be subjected to as little revi- sion as possible.The more independent and credible the index provider, the greater the benefit of the index, as this will help diminish the inherent subjective risk (moral hazard4) and increase the reliability of the index.Moreover, an index’s usefulness increases over time. Long-term historic values allow the correlation between the index and past loss events to be analysed and calculated precisely.

Indices that are updated frequently provide even greater benefits. For example, if an index is updated in real time, daily, or monthly, it can be correlated to specific events more quickly and more precisely. This can potentially facilitate liquidity and the effectiveness of a hedge.

Indices for the transfer of P&C risks

Property catastrophe industry loss indices are based on company losses caused by specific events, which are aggregated and then grossed up to an estimated industry loss number. Property catastrophe indices have facilitated the growth of the cat bond market, due to their widespread use as bond loss triggers, in particular for US exposures.

In the US, Property Claims Services (PCS) estimates industry losses by polling insurers, emergency managers and other parties. It provides information on insured property losses dating back to 1949. PCS figures have facilitated many transactions in the US. The more recent data include information at the state level, and sometimes ZIP code level, and are broken down into several insurance business lines. Basis risk can be reduced by utilising the detailed data to create customised indices. Furthermore, PCS is wholly owned by Insurance Services Office (ISO), a well recognised independent source of insurance data.

4 Moral hazard arises with traditional insurance when insured parties alter their behaviour so as to increase the potential likelihood or magnitude of loss. In risk transfer, moral hazard is present when the ceding company uses lax underwriting and risk management standards or applies relaxed claims settlement practices because the risk is transferred to another party.

Characteristics of an effective insurance index

Property cat indices have helped develop the cat bond market.


0

200

400

600

800

1 000

1 200

6th event

5th event

4th event

3rd event

2nd event

1st event

20

09

*

20

08

20

07

20

06

20

05

20

04

20

03

20

02

20

01

20

00

19

99

19

98

19

97

19

96

19

95

19

94

19

93

19

92

19

91

19

90

* January–July 2009 Note: The colouring of the bars refers to losses from different events during the same year. Many of the instruments discussed in this sigma are triggered by such single event losses. Sources: PCS, Swiss Re Economic Research & Consulting

In other regions, the growth of the cat bond market has been hindered to some extent by the lack of an effective industry loss index and by available reinsur-ance capacity. Cat bonds are generally for “peak” risks – low frequency, high severity events, such as hurricanes in the US Gulf region, for which there is limit-ed insurance capacity. To date, the index-based transactions that are traded for European risks are based either on modelled loss indices or on industry loss es-timates compiled by Swiss Re’s sigma or Munich Re’s NatCatSERVICE research units. Swiss Re’s sigma has been publishing data on major losses since 1970. Information is collected from various sources, including newspapers, direct insurance and reinsurance periodicals, specialist publications and reports from insurers and reinsurers. Munich Re’s NatCatSERVICE database contains major catastrophes dating back to 1950. Market participants have reluctantly used these estimates as triggers because to date they have lacked alternatives with a higher level of transparency and independence.

Industry participants have created a data service to provide property catastro-phe indices for regions outside the US (see box PERILS – Industry loss index Europe). PERILS, an independent company, will assess industry losses in Europe by polling insurers. Initially, PERILS will capture European wind events for which total insured losses exceed the financial threshold of EUR 200m. In addition to industry loss estimates, PERILS will also provide aggregated industry-wide ex-posure data (insured values) by risk type and CRESTA zones. 5 Exposure data will be provided on an annual basis.

5 CRESTA zones are defined European geographical zones for natural catastrophes insurance.

Figure 2: PCS estimates of losses caused by windstorms and thunderstorms in Geor-gia, United States, by single event loss (USDm, 2008 prices, 1990–2009)

In Europe, the growth of the ILS market has been hindered by the lack of an effective market loss index.

PERILS, an independent body, will collect loss information in Europe.



*Note: RMS provides catastrophe risk assessment models and modelled loss indices for many countries.

Source: Swiss Re Economic Research & Consulting

Table 1: Selected property catastrophe indices

Characteristic

PCS

Sigma

NatCatSERVICE

RMS Paradex

PERILS Industry loss index Europe

Area covered

US

Worldwide

Worldwide

USA, Europe

Over time, will include all European countries in which sufficient exposure data can be collected

Reporting units Individual states Country/state Country ZIP codes CRESTA zonesInsured exposure

Property

All excluding third-party liability

All excluding third-party liability

Residential property, commercial property, auto

Property

Perils

Hurricanes, tornadoes, hail, windstorms, winter freezes, earth-quakes, riots, fires, floods and explosions

Natural catastrophes, man-made disasters

All natural perils

Hurricanes, earth-quakes, fire after earthquake, tornadoes/hail

Initially windstorms in Europe, expanding to earthquakes and other perils, once windstorm data are established

Index basis

USD

USD, persons dead/missing, injured or homeless

USD and EUR

USD and EUR

EUR

Sub-indices

Industry estimates are provided on a state-by-state basis

Insured losses/total economic losses

Insured losses/total economic losses

US hurricane and earthquake regions, CRESTA for Europe

Industry estimates are provided at the CRESTA level

Source of data

US insurers voluntarily provide loss informa-tion

Various

Various

Meteorological and seismological parameters

European insurers to voluntarily provide information

Data history

1949

1970

All loss events since 1970 worldwide; major catastrophes since 1950; major historical events starting from 79 AD

N/A

PERILS plans to be in operation by the end of 2009

Event thresholds USD 25m insured property losses

Dependent on loss category

Dependent on loss category

N/A EUR 200m

Where index trades Mainly OTC, also Eurex, IFEX

OTC OTC OTC Operational by the end of 2009

Type Industry loss Industry loss Industry loss Parametric index Industry loss


PERILS – Industry loss index Europe

An independent company named PERILS (Pan-European Risk Insurance Linked Services) has been formed by eight shareholders consisting of (re)insurers and intermediaries (AXA, Allianz, Groupama, Guy Carpenter, Munich Re, Partner Re, Swiss Re, Zurich). PERILS will aggregate industry-wide exposure and claims data for Europe. Over time, the body will finance itself by charging fees for data services.

The initiative has two main goals. First, it aims to provide transparent and inde-pendent industry exposure and loss estimates that will stimulate development of new products and create additional insurance capacity. Second, it should improve modelling and assessment of nat cat risks, as well as underwriting and risk management, based on the data provided by PERILS.

The creation of the market loss index will benefit the European insurance indus-

try by improving the transparency of industry losses. Standardised, consistent and timely market loss data are expected to facilitate the future growth of the European cat bond and ILW markets. Furthermore, the data will help insurers identify exposure trends, sharpen their reinsurance requirements and benchmark their own risk portfolio’s performance against the industry exposure portfolio provided by PERILS.

PERILS has begun providing loss estimates for European windstorms and intends

to be fully operational in January 2010.

Longevity/mortality indices

Longevity risk is a major concern for individuals, employers, pension plans, in-surers and governments. A liquid, transparent and active longevity risk market would enable those institutions with substantial longevity risk exposure to hedge this risk, while allowing others to trade and invest in it. To get there, various longevity/mortality indices have recently been introduced. These can also be used to manage mortality risk.

Eight major industry participants have become founding shareholders of PERILS.

The index aims to stimulate growth of the ILS market and improve modelling.

As industry losses become more transparent, the industry as a whole will benefit.

Longevity indices help pension funds and providers of annuities to assess risk.



Although it is no longer publicly provided, a first attempt to develop a longevity/mortality index was made by Credit Suisse in 2005 based on the US popula-tion’s life expectancy statistics. Other recently launched longevity indices – the J.P. Morgan LifeMetrics index launched in 2007 and the Deutsche Börse Xpect index launched in 2008 – also source publicly available population data, and thus track general demographic trends (see Table 2: Recently launched longevity indices). For general population indices, adverse selection6 is not an issue. The data is verifiable, cannot be manipulated, and is provided by a reliable public source. It is widely applicable, although transactions based on such indices may be subject to substantial basis risk for the sponsor because of a mortality mis-match between the entire population and the insured population.

10

12

14

16

18

20

MalesFemales

20052000199519901985198019751970

Years

Source: J.P. Morgan, LifeMetrics, http://www.jpmorgan.com/pages/jpmorgan/investbk/solutions/lifemetrics/historictable

Another index that was recently launched by Goldman Sachs, the QxX index, tracks a representative sample of the insured US population over the age of 65. The index data is provided by American Viatical Services (AVS) and references a pool of up to 50 000 people who have participated in life settlement transac-tions. The pool’s mortality experience is tracked by an independent, third-party agent, and is based on the Social Security Death Index.7 The index is specialised in that it focuses on a narrow segment of the elderly population that tends to be skewed towards the more health-impaired portion of the life insurance market and, as such, would not be well-suited as a reference for pension funds and pro-viders of annuities. Moreover, the index may lack transparency and data might be difficult to verify.

6 Adverse selection occurs when a protection provider cannot distinguish between different classes of risk due to asymmetric information. Those with a favourable risk profile may opt out of insurance, leaving only those with a less favourable risk profile in the risk pool, which will lead to an underwriting loss.

7 For details, see http://www.qxx-index.com/

Most longevity/mortality indices track the general population…

Figure 3: Period life expectancy at age 65 for the US population

…but some track pools of individuals.



Weather indices for transferring insurance risk

Energy, agriculture, transportation, construction, municipalities, food processors and travel agencies are all examples of industries whose operations and profits can be significantly affected by the weather. Energy companies, for example, face higher demand for power when temperatures are very high or very low.

Weather risk management products allow organisations with exposure to ad-verse or unexpected weather conditions to mitigate those risks. They can be in derivative and insurance form. A weather contract can use many different types of information as its basis, depending on the event that is of most concern. Some examples include the number of days above or below a certain tempera-ture, area yields, wind speed, and extremes in rainfall. For example, an index contract that protects against excess rainfall would begin making payments once rainfall exceeds the strike level within a defined time period (eg a month, a season etc). Payments could be scaled to increase as the rainfall exceeds the strike level.

The most common weather derivative products reference temperature indices based on heating degree day (HDD) and cooling degree day (CDD) indicators. HDDs are a reflection of heating usage (the colder the temperatures, the greater the heating usage, the higher the HDDs), while CDDs reflect cooling usage (the warmer the temperatures, the greater the cooling usage, the higher the CDDs).

Table 2: Recently launched longevity indices

Index Deutsche Börse Xpect Goldman Sachs QxX J.P. Morgan LifeMetricsArea covered Germany, Netherlands US US, England & Wales,

Netherlands, GermanyPerils Longevity/mortality Longevity/mortality Longevity/mortalityIndex basis

Life expectancy, mortality rate

Realised mortality experience of the reference pool of lives

Life expectancy, mortality rate

Sub-indices By age, gender, cohort, customised portfolio

By age, gender By age, gender

Source of data Official data, plus proprietary sources

Sample of the US insured population

Official data

Data history since

1900 for Germany, 1920 for Netherlands

2007

1968 for US, 1961 for England & Wales, 1951 for Netherlands, 1952 for Germany

Frequency of updates

Monthly Monthly Annually

Where index trades

OTC OTC OTC

Many industries are affected by the weather.

Weather risk management products allow organisations with weather- related exposures to mitigate those risks.

Temperature indices are often referred to in weather risk management products.



Mexico’s vegetation index-based farming insurance

The Mexican government is interested in providing support to small farmers who are often at the mercy of extreme climatic events such as droughts. In re-cent years, the Mexican federal government has had to provide financial assist-ance after the occurrence of such events, mainly droughts.8 The assistance was mostly for animal feed to save livestock from perishing in the drought. This prompted the government, through Agroasemex, its wholly owned reinsurance company, to explore alternative instruments to manage climate-related risks.

The first transaction based on a vegetation index, derived from satellite images,

was launched in May 2008. A model established that there was a high correla-tion between the climatic events registered by the satellites and production levels of the plant species that are used in animal feed.

The transaction sets an example that is likely to be followed by other countries facing similar exposures. Vegetation index data is available worldwide, admin-istered by the National Oceanic and Atmospheric Administration. Insurance based on vegetation indices offers a solution that accurately reflects pasture land conditions, virtually eliminating moral hazard and providing an objective mechanism of settlement.

8 Source: Agroasemex La experiencia Mexicana en el desarrollo y operación de seguros parametricos orientados a la ganadería, August 2006. http://201.158.1.169/agroasemex/index.php/inicio.html

Agricultural production plays an impor-tant role for the Mexican economy and is highly vulnerable to climate related risks.

A vegetation index serves as a trigger.

The innovative solution provides various benefits.


Instruments that transfer insurance risks to the capital markets

Overview of the instruments A variety of instruments currently exist to transfer insurance risks to the capital

markets. These include:9

(1) Industry loss warranties (ILWs), which are in essence a reinsurance contract where the payoff depends not only on the insured loss of the buyer, but also on an industry loss index.

(2) Insurance-linked derivatives, which are distinct from insurance contracts, and do not require an insurable interest. They can be used to speculate for profit or to protect the downside of a risk by hedging. Currently, derivatives can be traded on an exchange or privately. In the latter case, they are said to be traded over-the-counter (OTC).

(3) Securitisations: P&C and life bonds remove assets, liabilities, or cash flows from the corporate balance sheet and transfer them to third parties through tradable securities.

Many, but not all of these instruments are based on indices (see Table 3). The focus in this sigma will be on those instruments that are index-based. Non-index-based instruments will only be addressed briefly.


9 Other instruments include contingent capital and side cars, which are not explored here. For a more detailed description of the various insurance risk transfer instruments, see sigma No 7/2006 “Securitization – new opportunities for insurers and investors”.

A wide variety of instruments exist to transfer insurance risk directly to capital markets.

Table 3: Overview of instruments for transferring insurance risks

Instrument Index-basedILWs yesDerivatives

P&C cat derivatives (OTC) yesMortality/longevity swaps yes, but not alwaysExchange-traded cat contracts yesWeather derivatives yes

Securitisations P&C cat bonds yes, but not alwaysExtreme mortality bonds yes, but not alwaysEV securitisations noAXXX/XXX securitisations noLife settlement securitisations usually not



Industry loss warranties

ILWs, in their basic form, are reinsurance contracts where the payoff depends on two triggers. The first trigger is the insured loss of the protection buyer, ie the indemnity. The second trigger is the insured industry loss, which can be based on either market losses or certain parameters. PCS, Swiss Re’s sigma and Mu-nich Re’s NatCat SERVICE are the three most widely used indices in ILWs. Both the indemnity and industry triggers have to be hit for the buyer of the ILW to receive a claims payoff. The threshold for the first condition (the actual insured loss of the insurer) is set low enough that it is very likely to occur if the industry loss is triggered. As such, the price of the ILW is primarily based on the risk as-sociated with the industry losses or index. Hence, they are easier to underwrite. Typical buyers and sellers of ILWs include insurers and reinsurers.

Non-insurance entities, such as hedge funds, have been the primary sellers of ILWs in recent years. One way for hedge funds to participate in the ILW market is to remove the indemnity trigger from the ILW. Strictly speaking, this transforms the product into a pure derivative. Nevertheless, it is still referred to as “ILW” by most market participants. In addition, many hedge funds have set up captive reinsurers purely to provide ILW protection and also, when necessary, use a fronting reinsurer.

Similar to index-based securitisations, ILWs have basis risk. However, they are less expensive to execute and consequently are contracted at much lower nominal amounts (eg USD 1m compared to USD 100m). The term of an ILW is usually one year, but can be shorter (eg the duration of one storm in a “live cat” transaction) or longer. The counterparty risk in ILWs is often mitigated by collat-eralisation.

Example of a typical ILW10

Most ILWs provide protection against severe losses. A reinsurance company seeking protection for its US nat cat exposure may purchase an ILW based on the overall US PCS index. The terms of the contract are as follows:

Term: 12 months from 1 January 2010 Industry loss attachment (warranty): USD 20bn Limit of protection: USD 10m Retention: USD 10 000 (usually small) Rate-on-line: 10% Reporting period: 36 months from the date of loss

10 See McDonnell, E. (2002). “Industry loss warranties“, in M. Lane (ed) Alternative Risk Strategies, London: Risk Waters Group.

An ILW is a reinsurance contract where the payoff depends on two triggers.

Non-insurance entities are participating in the ILW market.


This contract will pay out USD 10m in the event that PCS reports a loss event of USD 20bn or more during 2010, provided that the protection buyer sustains an ultimate net loss of USD 10 010 000. In the event that the loss reported by PCS is USD 19bn, the buyer has 36 months from the date of loss to make a recovery, if the original insured loss develops to satisfy the industry loss specified in the contract. (In derivative form, the requirement of the buyer’s ultimate net loss is dropped.)

The price paid upfront by the protection buyer amounts to USD 1m.

Most ILWs have a binary payoff, ie as soon as the industry loss attachment is reached and the indemnity losses are reported, the protection buyer will receive 100% of the specified limit. However, there are other payoff options. In the above example, one could have a linear payoff between industry losses of USD 20bn and USD 30bn. In that case, the protection buyer would receive 0% of the limit in the event of a USD 20bn PCS loss or below, 50% (ie USD 5m) in the event of a USD 25bn PCS loss and 100% (ie USD 10m) in the event of a USD 30bn PCS loss or higher.

Derivatives

Unlike insurance contracts, which require an insurable interest and an indem- nification, derivative contracts can be used to speculate for profit as well as to provide protection against the downside risk through hedging.

Currently, derivatives can be traded on an exchange or they can be traded pri-vately. In the latter case, they are said to be traded over-the-counter (OTC). OTC contracts are bilateral and can expose either party to credit risk (unless collateral is specifically negotiated). Exchange-traded contracts, usually futures and op-tions, are characterised by standard contract terms, meaning that all participants trade the same underlying instruments. This helps to generate a greater critical mass of liquidity, eventually leading to tighter bid-offer spreads and more cost-effective risk management solutions. 11

Catastrophe derivatives Catastrophe derivatives – also known as cat derivatives – are customised OTC

contracts. The ILW in derivative form described above – with a binary trigger on a single event loss – is the most common form of a cat derivative. Most cat derivative transactions involve a series of fixed, pre-defined payments that are exchanged for a series of floating payments, whose values depend on the occurrence of an insured event.

11 Eric Banks (2004). Alternative Risk Transfer, p 156, London: John Wiley & Sons, Ltd.

Derivatives are not insurance products.

Derivatives are traded over-the-counter or on exchanges.

The ILW in derivative form is the most common form of a cat derivative...



Like ILWs, cat derivatives are based on pre-defined indices. Apart from the standard industry loss binary trigger used in most cat derivatives, they can also be structured on aggregate industry losses for a specific peril over a pre-defined period, and on second or third event covers. Moreover, they can be structured to mirror the payoff of a specific cat bond. Some customised OTC cat derivatives use other types of triggers that are not prevalent in ILWs. This market falls some-where between the cat bond market and the ILW market and includes “cat-in-a-box” transactions that use parametric triggers. Relative to cat bonds, these are typically customised, smaller transactions (less than USD 50m at risk per event) with reduced liquidity relative to either ILWs or cat bonds.

Cat derivatives have some advantages over catastrophe bonds. Because they are simpler to implement and have lower fixed costs, they can be contracted at much lower notional amounts. Unlike cat bonds (and most ILWs), they are not always collateralised and can be exposed to credit risk. If the counterparty is an unrated cat investment fund, the cat derivative is usually fully collateralised. If, however, the counterparty is a rated entity, such as a major (re)insurance com-pany, collateral is usually not required. The majority of cat derivatives so far has been related to property risks in the United States.

Exchange-traded contracts The development of a public market for exchange-traded insurance derivatives

has been slow. In fact, early efforts by the Chicago Board of Trade (CBOT) to establish a market for exchange-traded catastrophe derivatives had to be aban-doned due to lack of interest.12

Recently, several exchanges have attempted to re-launch exchange-based trading of insurance derivatives. Currently, several contracts are traded on three different exchanges (see Table 4).13

Carvill developed a hurricane index, now called CME Hurricane Index, which is used as the basis for hurricane risk futures and options listed on the Chicago Mercantile Exchange (CME). This index measures the potential damage from a hurricane by combining the radius and the maximum sustained wind speed of the hurricane at landfall.

IFEX and Deutsche Bank launched catastrophe event-linked futures (ELFs) trad-ed on the Chicago Climate Futures Exchange. Recently, Eurex has listed very similar future contracts. These contracts have a binary payout, depending on single event (hurricane) PCS losses. They are similar to ILWs, but buyers of those exchange-traded contracts do not have to suffer direct losses to receive a pay-ment once the industry loss strike amount (measured by PCS) has been reached.

12 See Best’s Review, Back to the Futures, April 2008.13 Trading of cat derivatives on a fourth exchange – the New York Mercantile Exchange (NYMEX) – has

apparently been abandoned. The contracts were based on the Re-Ex index created by Gallagher Re (now taken over by Aon). The index was based on aggregate and cumulative PCS losses over a year and covered all perils except earthquake and terrorism.

… but other cat derivatives using different triggers also exist.

Cat derivatives have lower fixed costs than cat bonds.

Earlier efforts to develop a market for exchange-traded insurance derivatives failed.

Recently, there have been efforts to re-launch exchange-based trading of cat derivatives.


Note: CME Hurricane Index (CHI) Cat-In-A-Box represents modelled losses for hurricanes in specific US geographic regions, prepared by the modelling firm EQECAT. Sources: CME, IFEX, Eurex

Mortality/longevity swaps Recently, efforts have been made to create a market for mortality and longevity

swaps. These transactions can be either indemnity or index-based. In an index-based transaction, a fixed series of payments is swapped for a series of payments linked to the number of individuals from a reference population who die in a given year (in the case of a mortality swap) or who survive in a given year (in the case of a longevity or survivor swap).14 For example, a ten-year survivor swap, where the initial reference population is for 65-year-old men in a specific geo-graphical region, would make annual payments based on the number of people – aged 65 at the swap’s inception – who survive to age 66, 67, and so on until age 75. The fixed payments would represent the proportion of people who, at the swap’s inception, were expected to survive to these ages.15

14 David Blake, Andrew J.G. Cairns and Kevin Dowd (2009). “The Birth of the Life Market”, Discussion Paper PI-0807, Pensions Institute.

15 Paul Sweeting (2008). “The market for mortality”, (http://www.the-actuary.org.uk/697965).

Table 4: Exchange-traded contracts

Exchange

Chicago Mercantile Exchange (CME)

IFEX/Chicago Climate Futures Exchange

Eurex

Index CME Hurricane Index

PCS PCS

Underlying parameters

Wind speed and hurri-cane-force radius at landfall; one contract per landfall

Binary PCS losses

Binary PCS losses

Perils

Hurricanes making landfall in the Eastern US. Named hurricanes within the CHI-Cat-In-A-Box (see Note below)

Named hurricanes breaching trigger

Named hurricanes breaching trigger

Instruments Futures, options Event-linked futures Event-linked futuresRegions

Eastern US, North Atlantic Coast; Southern Atlantic; Florida, Gulf Coast, Gulf Offshore

US Nationwide, Gulf (Alabama, Louisiana, Mississippi, Texas), Florida, US Eastern Seaboard (Georgia to Maine) and US Northeast (Virginia to Maine)

US Nationwide, Gulf (Alabama, Louisiana, Mississippi, Texas), Florida

Mortality/longevity swaps can be either indemnity or index-based.



Weather derivatives Weather derivatives are contracts referencing weather-related indices, such as

temperature, precipitation, wind etc (see previous chapter). They allow organi-sations with exposure to adverse or unexpected weather conditions to mitigate those risks. Energy companies, for example, face higher demand for power when temperatures are very high or very low. In addition, construction companies use weather derivatives to hedge against precipitation or cold that can disrupt con-struction schedules. Increasingly, farmers and agribusinesses are also buying temperature and precipitation derivatives to protect revenues and yields.

Certain market dealing conventions have developed in the OTC market, including contract size, limits, tenor and reference cities. This has helped create reasonable liquidity in such OTC markets. In recent years, however, liquidity has surged in the contracts traded on the Chicago Mercantile Exchange (CME). This appears to have happened at the expense of OTC market liquidity.

Drought cover in Malawi through a weather derivative contract

The economy of Malawi is highly vulnerable to adverse weather shocks because agriculture accounts for about 40% of GDP. The main staple crop is maize, grown by smaller farms mostly at the subsistence level. An adverse weather shock may lead to a shortfall in maize production. If prices become volatile, strains in the food supply could occur.

In October 2008, the Government of Malawi entered into a weather derivative agreement with the International Development Association (IDA), the arm of the World Bank that helps the world’s poorest countries. In exchange for a premium, Malawi was covered against drought-related financial risk over the subsequent seven months. The World Bank entered into a mirroring agreement with Swiss Re, which compensates the World Bank if the rainfall index – the trigger – reaches a certain level.

As with all index-based contracts, the deal involves basis risk, ie there may be a mismatch between the actual shortfall of maize production and the shortfall as indicated by the index. Such a mismatch may arise if the production shortfall is caused by floods or pests, for example, which will not be reflected adequately in the index.

Weather derivatives allow organisations such as utilities to mitigate their weather-related risks.

Temperature-based weather derivatives have become fairly standardised.

Malawi’s agricultural economy is vulnerable to weather shocks.

Malawi now has protection against drought.

As with all index contracts, there is basis risk.


Securitisations

P&C bonds typically provide protection for extreme events, such as hurricanes and earthquakes in densely populated areas. Life bonds may also transfer peak risk, such as a sharp increase in mortality, but most life bonds have been financ-ing vehicles (see box Non-index-based life securitisations).

The bulk of P&C insurance securitisations to date have involved catastrophe bonds, commonly known as cat bonds. There have been only very few securiti-sations of non-catastrophic risks, such as liability, credit, motor and reinsurance recoverable risks. In a typical transaction, a special purpose vehicle (SPV) enters into a reinsurance contract with a cedent and simultaneously issues cat bonds to investors. If no loss event occurs, investors receive a stream of coupon pay-ments and a return of principal that compensate them for the use of their funds and their risk exposure. If, however, a pre-defined catastrophic event does occur, investors suffer a loss of interest, principal or both. These funds are transferred to the cedent, in fulfilment of the reinsurance contract. While – until recently – most cat bond structures involved a swap counterparty that converts the invest-ment returns on the collateral into a LIBOR-based rate (see Figure 4), some of the cat bonds issued in 2009 used different structures without a swap counter-party (see Figure 5).

Investments

Investmentearnings

Investmentearnings

Premiums

Contingentclaim payment

Principal andinterest

Scheduledinterest

Notes

Cash proceeds

SPVReinsured Investors

SwapCounterparty


P&C bonds usually provide protection for extreme events, whereas life bonds are mostly financing vehicles.

P&C cat bonds pay out when a pre-defined event occurs.

Figure 4: Structure of a cat bond with a swap counterparty



Investments

Risk transfercontact

Premium

Scheduledreturn

Note proceeds

Coupon: ref. rate + [ ]%

Return of remaining principal

SPV

Collateral trust

Sponsor

1 2

3

Investors

Stable valueinvestment

1 The reinsured enters into a risk transfer contract with a special purpose vehicle (SPV).2 The SPV hedges the contract by issuing notes to investors in the capital markets.3 Proceeds from the notes are invested in assets to maintain stable value and generate a floating return (the reference rate).


Cat bonds can be distinguished by the type of trigger. While investors prefer to maximise the transparency of the trigger for cat bonds, sponsors seek to minimise the basis risk. Transparency, however, as shown in Figure 1, is often associated with higher basis risk. Cat bonds use a variety of triggers. Hence, the trade-off between transparency and basis risk appears to be well managed.

Life securitisations can also be used to transfer mortality and longevity risks. For example, life (re)insurers can hedge against a pandemic flu or a sharp increase in longevity through securitisations. Extreme mortality bonds are similar to P&C cat bonds in that they, too, are fully collateralised and have a specified trigger, ie a mortality index.

So far, no pure longevity bond transactions have been placed. There has only been a single public attempt to issue a longevity bond, which was ultimately abandoned. The bond, structured by BNP Paribas in 2004, targeted annuity providers and pension plans to provide a hedge for their longevity risk. It was unsuccessful for a number of reasons, including the structure of the bond,16 the receptivity of the investor community and its low yield.17 However, there is an active life settlements market that absorbs some longevity risk.

16 For an annuity book or pension plan, one cohort of 65-year-old males was considered a poor hedge against longevity. Also, unlevered exposure to longevity risk meant that it required a large amount of up-front capital for the level of protection it offered. Moreover, there was no final settlement at maturity to reflect longevity risk in the liabilities beyond the bond’s 25-year maturity.

17 J.P. Morgan Global Market Strategy: “Longevity: a market in the making”.

Figure 5: Typical recent structure of a cat bond

There are various types of triggers for cat bonds.

So far, attempts to issue longevity bonds have failed.


Non-index-based life securitisations

Most life securitisations – with the exception of extreme mortality bonds – are used primarily as a financing tool rather than as a risk transfer instrument.18 There are usually no triggering indices involved.

Life bonds can be used to monetise intangible assets such as deferred acquisi-tion costs and the present value of future profits, ie embedded value (EV) securi-tisations. Life bonds are also used to fund US regulatory capital requirements (XXX/AXXX securitisations) or to securitise a portfolio of life settlements.

The total volume of outstanding life securitisations, including extreme mortality bonds, was USD 22.2bn at year-end 2008. The bulk of life bonds are either embedded value or XXX/AXXX deals (roughly 42% each). The remainder includes extreme mortality and other securitisations, such as life settlement securitisations.

0

5

10

15

20

25

Regulation XXX/AXXX

Other – life

Extreme mortality

Embedded value

200920082007200620052004200320022001200019991998

in USD bn


The credit crisis caused disruptions in the market for life bonds due to the general rise of spreads on asset-backed securities, including life ILS. This reduced the attractiveness of life securitisations for issuers as they had become less profitable.

Many life securitisations involved guarantees of timely principal and interest payments by a monoline insurer. After the rating downgrades of the monolines and their withdrawal from the structured finance business, the traditional struc-tures were no longer feasible, making them more expensive for issuers. Also, as investors in life securitisations have not typically been specialised ILS investors, they had relied on the guarantees by the monolines and the corresponding high rating. It remains unclear if investors will adjust to new, potentially unwrapped structures of life securitisations.

18 For more detailed information on life securitisations, see sigma No 7/2006 “Securitization – new opportunities for insurers and investors”.

Life bonds are typically used as a financing tool.

The bulk of life securitisations are EV and XXX/AXXX deals.

Figure 6: Life securitisations outstanding by type

The general rise of spreads on asset-backed securities impaired the life bond market.

The absence of monolines has caused problems for traditional investors.




Table 5: Summary of insurance risk transfer instruments

P&C cat bonds

Extreme mortality bonds

Industry loss warranties (in reinsurance form)

Cat derivatives (OTC)

Exchange- traded cat derivatives

Mortality/ longevity swaps

Weather derivatives

Basis risk/ tail risk

Depends on trigger

May be signifi-cant if it is index-based

May be signifi-cant since it is index-based



Can be signifi-cant, depending on index

Can be signifi-cant, depending on trigger

Moral hazard posed to risk-taker

Low if index-based/para-metric trigger, medium if indem nity-based, can be mitigated via contract design

Low if index-based

Low

Low if index-based

Low

Low if trigger is index-based

Low as trigger is index-based

Counterparty risk

Low as capital is usually invested in high-quality securities held by trustee

Low as capital is usually invested in high-quality securities held by trustee

Yes, unless limit is collateralised

Yes, unless limit is colla-teralised

Low as default of exchange is very unlikely

Yes, unless limit is collateralised

Minimal if traded on exchange. Yes if traded OTC and not collateralised

Liquidity for risk-taker

Medium

Low

No liquidity since these are private deals

Depends on form; liquidity high for standardised contracts

Low so far as volume is still too small, but may increase in the future

Low

Medium for some standard OTC contracts. High for exchange-traded products

Standardisation

Customised

Customised

Many contracts standardised

Varies

Standardised

Customised

Exchange-traded and some OTC products stand-ardised; other OTC products customised


Benefits and market challenges

As discussed in the previous chapters, the development of indices has led to the transfer of more insurance risks to the capital markets. Increasingly, portions of peak catastrophic risks– from earthquakes, hurricanes, floods, windstorms and pandemics – have been transferred to investors through securitisation and de-rivatives transactions. The emergence and evolution of index-linked risk transfer instruments has facilitated the spread of risks to a wide investor base from one where risks had traditionally been borne by shareholders or bondholders.

Index-linked risk transfer instruments provide numerous advantages for (re)in-surers and investors. However, the marketplace also presents many unique chal-lenges. In this chapter, we review many of the benefits of index-linked contracts as well as some of these challenges.

Benefits of index-linked risk transfer

Along with financial innovation, the development of indices that are used as triggers in risk transfer instruments has played an important role in facilitating the growth of risk markets. By helping to expand the range of insurance risks that can be transferred to investors, indices benefit both (re)insurers and inves-tors. (Re)insurers benefit from having additional capacity and new tools for risk and capital management. Investors, in contrast, benefit from having an additional asset class with returns that are typically uncorrelated with those of other invest-ments.

Indices help broaden risk transfer markets. For investors, a good index is often easier to understand than underlying insurance exposures. Buyers of traditional insurance often find that the coverage they seek is either unavailable or prohibi-tively expensive, particularly for exposure to large (mega-)risks. Index-based instruments have provided tools to governments and previously uninsured indi-viduals and businesses to protect against losses from nat cat and weather-related events at lower costs than traditional insurance.19 In the developing economies, innovative index-linked solutions have allowed governments and relief organisa-tions to transfer part of the financial burden of natural disasters to the capital markets.20

Indices facilitate contract standardisation. Insurance policies tend to be more complex than other securitised products such as auto loans. Index-linked con-tracts, however, are generally easier to standardise than indemnity contracts. Objective and transparent indices facilitate standardisation, thus reducing insur-ance design and administrative costs. Standardised contracts can also be traded more easily in secondary markets, which improves liquidity and facilitates risk transfer and portfolio diversification. Moreover, the standardisation of contracts and easier claims settlement make index-based insurance policies more cost-efficient. Lower administration costs may be passed on to the client through lower prices.

19 Insurance of agricultural risks on an indemnity basis can be complex and very expensive in terms of underwriting and claims handling costs. Alternative index-linked weather insurance programmes have been established successfully in a number of emerging economies in Asia, Africa and Latin America.

20 For example, in 2007, Swiss Re launched a GlobeCat securitisation programme to transfer Central American earthquake risks to investors. The trigger mechanism links the payoffs to the size of the population affected by a specific earthquake.

The development of indices has led to the spread of more insurance risks to investors.

This chapter reviews the benefits and challenges of index-linked contracts.

Index-linked risk transfer provides additional capital capacity for (re)insurers and diversification opportunities for investors.

The benefits of indices include: … broader risk transfer markets,

…contract standardisation and improved market liquidity,



Indices facilitate new product offerings. Index-linked risk transfer works best when the reference index correlates well with the damages or losses occurring from a specified event, unlike traditional insurance, which is most useful in com-pensating for losses from independent events. For example, index-linked instru-ments can be used as a mechanism to write farm-level insurance when high correlation is present between climatic events and agricultural production levels (see box Mexico’s vegetation index-based farming insurance).

Indices reduce moral hazard. Index-linked contracts are unlikely to create moral hazard issues because payouts are based on an independent metric, rather than the insured’s reported losses. For example, the use of an industry loss index re-duces moral hazard because a company cannot greatly influence industry losses related to a certain event, whereas it can influence its own losses.

Indices reduce adverse selection. The use of index-linked instruments reduces adverse selection because payments are based on widely available information and there are few informational asymmetries to be exploited. Risks can be cal-culated more easily and priced more accurately, without depending on informa-tion provided by the insured party.

Indices can provide important information for pricing of insurance risks. Indices can lead to the development of liquid risk trading markets that could play an important role in setting efficient insurance risk prices. Currently, the trading of index-linked instruments is confined to cat bonds, standardised ILWs and ex-change-traded contracts. The size of risk trading markets is small. Nonetheless, a regular comparison of observed trading and prices of risk-equivalent traditional cat insurance contains some relative price information for (re)insurers. In the future, if risk transfer markets expand in size and scope to offer a complete set of traded instruments and risks, capital market pricing could provide tremendous value as an input for the pricing of a variety of insurance risks.

… new product offerings,

… reduced moral hazard,

… less adverse selection and

… important information for pricing of insurance risks.


Cat bonds offer investors attractive returns

In each year since the end of 2001 – the inception of the Swiss Re Cat Bond Performance Index – cat bonds have earned a positive return. Between the end of 2001 and July 2009, cat bonds generated a cumulative 61% return, com-pared to 67% for BB-rated US corporate bonds, 50% for US investment grade corporate bonds and 53% for US treasuries. Over this time period, US equities lost 13%.

60

80

100

120

140

160

180

US corporate IG US treasuries

Equity index, S&P 500

US BB corporate

BB-rated cat bond

May

09

Jan

09

Sep

08

May

08

Jan

08

Sep

07

May

07

Jan

07

Sep

06

May

06

Jan

06

Sep

05

May

05

Jan

05

Sep

04

May

04

Jan

04

Sep

03

May

03

Jan

03

Sep

02

May

02

Jan

02

Note: Swiss Re BB-rated Cat Bond Index Total Return, calculated by Swiss Re Capital Markets (“SRCM”), is a market value-weighted basket of nat cat bonds tracked by SRCM, calculated on a weekly basis; past performance is no guarantee of future results. Underlying data for “Swiss Re Cat Bond Index Total Return” is based on indicative prices only. Underlying data for S&P 500 Index is provided by Standard & Poor’s. The S&P index is the property of Standard & Poor’s, a division of the McGraw-Hill Companies, Inc. Underlying data for Barclays Capital bond indices provided by Barclays Capital. The Barclays Capital indices are the property of Barclays Capital, a division of Barclays Bank Plc.


Market challenges for insurance-linked instruments

Along with the many advantages of insurance risk transfer, market participants face a number of challenges. Some of these challenges – faced by both spon-sors and investors – relate to insurance-linked products, while others are specific to index-linked instruments. They can be grouped into the following categories: (1) indices; (2) risks; (3) market/product transparency; (4) regulatory and ac-counting rules; and (5) rating agency treatment. In this section, an overview of the most important challenges is provided as well as potential ways to address them.

Cat bonds have had high returns.

Figure 7: Returns of cat bonds versus stock & bond returns (End 2001=100)

The market challenges can be grouped into five categories: indices, risks to sponsors and investors, market/product transparency, regulatory and accounting rules and rating practices.



Indices More work needs to be done to develop new indices and improve index

quality. Problems related to data availability, timeliness and frequency need to be resolved.

New indices: As discussed earlier, the PCS index is an established, well- accepted and widely-used trigger for cat bonds, ILWs and cat derivatives in the US. The lack of similar industry-loss indices for Europe and Asia has hindered the ability to price, manage and transfer cat risks to investors. The recently launched PERILS European market loss index will likely fill this gap and facilitate the development of a nat cat risk trading market in Europe. Similar initiatives have yet to be launched in Asia.

Availability of quality data: Availability of high quality data on exposures is a problem in the EU, where there are no standard formats for collecting or reporting policy information. In some cases, metrics used vary by country. In the US, the collection of wind speed data could be improved. In the absence of a comprehensive network of wind measuring stations similar to AMeDAS in Japan, parametric indices must instead rely on imputed wind speeds based on storm track data from the National Hurricane Center.

Data timeliness and frequency: Data timeliness and frequency are challenges for mortality and longevity indices, as official data are usually published annu-ally and with a significant time lag. Government support for the timely collec-tion and publication of more comprehensive and frequent mortality/longevity data is important for the development of a mortality/longevity risk transfer market. Moreover, low frequency data inhibits trading between reporting dates and may create an illiquidity premium.

Granular indices: Creating more granular or disaggregated indices is key for reducing basis risk for sponsors. For nat cat risks, indices should provide a geographic breakdown that allows sponsors to refine the trigger and mini-mise their remaining loss exposure. Similarly, for mortality risk, indices should be available for different segments of the population. Cat bonds handle this quite well by building customised indices that minimise basis risk, relying on underlying indices as building blocks.

New indices are needed to expand P&C risk transfer markets in Europe and Asia.

Index improvements should focus on data availability, …

… timeliness, frequency …

… and granularity.


Risks The main risks for investors participating in index-linked insurance risk transfer

transactions are counterparty credit risk and liquidity risk. Sponsors, in contrast, are exposed to basis risk and market capacity risk. However, all market partici-pants face both legal risk and systemic risk.

Counterparty credit risk: Counterparty credit risk is present in OTC transactions unless they are fully collateralised. For exchange-traded instruments, credit risk is handled by an exchange which acts as an intermediary for the counter-parties in the transaction and guarantees trades. In securitisation structures, counterparty credit risk is mitigated by setting up a special purpose vehicle (SPV) with a trust invested in highly-rated low-risk securities and managed by a total return swap (TRS) counterparty that guar-antees the cash flow of payments due to investors. Lehman’s bankruptcy revealed that these structures could still expose investors to substantial coun-terparty risk if the TRS counterparty defaults at a time when collateral assets are severely impaired. This problem has been successfully resolved by impos-ing greater transparency and tighter collateral requirements, eg government-guaranteed collateral (see box The impact of the Lehman Brothers default on cat bonds).

The impact of the Lehman Brothers default on cat bonds

Cat bonds typically provide protection for several years, leaving the invested collateral exposed to fluctuations in financial markets. In order to make sure that the protection for the sponsor is fully available, along with interest payments and any outstanding principal due to be paid to investors at maturity, the cat bond structure typically involves a total return swap (TRS) (see Figure 4).

The role of the TRS counterparty is to replenish the collateral in the event that the latter becomes deficient. In addition, the TRS counterparty converts the investment returns on the collateral into a LIBOR-based rate that is consistent with the cat bond’s accrual of interest. The credit risk related to the TRS counter-party was – before the breakout of the credit crisis – considered to be almost negligible since such counterparties had to be highly rated entities.

This view was challenged after the collapse of Lehman Brothers in September 2008. Lehman was the TRS counterparty to the collateral accounts of four cat bonds. The failure of Lehman left investments in these accounts without protec-tion. This would not have resulted in any major problems had the assets in the collateral accounts been very high quality. However, because the collateral had a wide variety of assets and because all non-government backed assets have been affected by the financial crisis, investors were left holding assets with an uncertain payout.

Counterparty risk is present in OTC transactions that are not fully collateral-ised.

In ILS, greater transparency and tighter collateral requirements minimise credit risk.

Investment risk of the cat bond’s collateral is usually protected by a total return swap.

The TRS counterparty assumes the investment risk and converts returns into a LIBOR-based rate.

The demise of Lehman Brothers left four cat bonds exposed to investment risk.



The ratings of the four transactions were subsequently lowered and prices declined, reflecting the likely payment shortfall. By the end of July 2009, two of the four bonds had gone into default, as they had failed to make full interest or principal payments.

As counterparty and investment risks in cat bond structures have become more prominent since the Lehman default, there have been a number of measures addressing the current shortfalls, including:

Enhanced transparency with regard to the investments held in the collateral trustTighter investment restrictions for the collateral account regarding quality, liquidity, asset concentration, duration and over-collateralisationMore frequent mark-to-market of the collateral with the TRS counterparty required to post any shortfalls to the collateral account (“top-up” provisions) Alternatives to the traditional TRS structure such as posting the collateral in a bank depositSome of the more recent deals have already implemented some amendments, such as increased frequency of “top-up” provisions.

Over-the-counter derivatives are often collateralised in the form of cash or acceptable securities that are held in trust at depository institutions, or by bank letters of credit, thus minimising and, in certain cases, eliminating credit risk. For financial risk instruments, such as currency, equity or interest rate derivatives, the International Swaps and Derivatives Association (ISDA)21 has developed a set of legally enforceable credit support agreements to minimise credit risk. OTC cat derivatives also use the ISDA Master Agreement, but no specific credit agreements are in place for this type of derivative. If the coun-terparty is a rated entity, such as a major (re)insurance company, collateral is usually not required. To facilitate the development of the market, a standard derivative contract for trading nat cat risks has been developed, the Swiss Re Natural Catastrophe Swaps (“SNaCSTM“). The contract is available for US wind and earthquake events. In addition, the ISDA working group, Stand-ardisation of Cat Swap Documents, has finalised the first standardised ISDA catastrophe swap document – The US Wind Event Confirmation.

Liquidity risk: Liquidity risk arises when it is difficult to generate a secondary market for the trading of contracts. Investors in ILS, ILWs and derivatives contracts are exposed to liquidity risk – just like investors in other asset classes – when it may not be possible to find another counterparty to assume the contract, or negotiate an offsetting contract. The liquidity of risk transfer instruments is closely linked to the standardisation of contracts. Standardised instruments that are traded on exchanges have the potential to develop into a very liquid market, such as the market for weather derivatives.

21 ISDA is a global trade association of participants in the privately negotiated derivative industry.

Those four cat bonds were consequently downgraded sharply.

The market has now changed and future issuance will be more transparent.

Over-the-counter derivatives need rules to minimise counterparty risk.

Standardisation of contracts is impor-tant for minimising liquidity risk …


. Legal risk: Legal risk occurs due to the challenges of designing a legal frame-

work with clear property rights defined with simple, homogeneous and transparent contracts. This is particularly relevant to instruments lacking standardised documentation. Terms, trigger definitions and loss payouts may not be clearly defined in the contract, possibly exposing both the buyer and seller to legal risk. In index-linked contracts, indices have to be provided by an independent party following strict integrity standards in order to avoid legal risks. Standardisation of contracts is an important step towards minimising this risk.22

Basis risk: Basis risk arises in index-linked instruments when the sponsor attempts to protect a risk exposure with a proxy, ie an index trigger, which provides payments that do not perfectly match the potential loss. The devel-opment of granular indices that correlate well with potential losses can alle-viate basis risk.

Capacity risk: Capacity risk occurs when investors withdraw capital from the risk trading market. For nat cat risks, this may occur after a big catastrophic event that creates large losses for investors. Large capital withdrawals reduce market liquidity and may create serious interruptions in the functioning of (re)insurance markets if investors provide a material share of the total risk capacity, especially for peak risks.

Systemic risk: The recent credit crisis and subprime debacle revealed that risk markets, when not adequately supervised, can create distortions with wide-spread consequences for the stability of the financial system. These have affected the ILS market, even though the underlying risks have not changed. First, the wider credit market problems revealed weaknesses in financial guarantee insurers and rating agencies. Neither of these two industries were analysing structured securities adequately. Second, the credit crisis revealed the need to adequately review the underlying assets in insurance-linked secu-rities and the counterparties involved in total return swaps. Finally, the crisis has highlighted the need for increased transparency and full disclosure of risks, as well as robust underwriting discipline and well-aligned incentive structures for all market participants.

Model risk: Insurance-linked securities and related instruments – like insurance contracts – rely on models to quantify the insurance risks involved. There is therefore a risk that these models may be incorrectly specified.

22 ISDA continues to improve cat swap contract standardisation – eg a US wind template was recently published.

… and legal risk.

Cedents may incur basis risk during index-linked risk transfers.

Capacity risk may reduce liquidity and create capacity shortages.

The financial crisis highlighted the importance of dealing with systemic risk.



Market/product transparency Understanding insurance risks can be a challenge for investors. Investor educa-

tion, improved disclosure of risks and pricing transparency will help broaden the market and improve liquidity.

Investor education and improved risk disclosure: Insurance risks that are easily understood by potential investors can be transferred most efficiently. Investors need comprehensive and frequently updated information. Standardised and timely disclosure of risk exposures and loss experiences will help broaden the range of potential investors and improve market liquidity.

Pricing transparency: Easy access to information on pricing of risk transfer contracts is only available for cat bonds and exchange-traded risks. ILW and cat swap pricing is less transparent. More risk transfer and the full development of exchanges for trading insurance-linked risks will help improve information and pricing transparency.

Regulatory and accounting rules Regulatory and accounting rules influence whether and how widely new risk

transfer instruments are used. Current regulatory and accounting rules create some ambiguities in the treatment of instruments that transfer insurance risk to the capital markets, but in most cases do not pose major impediments to the risk transfer market. Some transactions are treated as reinsurance, while others are treated as financial instruments. For the most part, existing regulatory and accounting rules only modestly inhibit index-based transfer of nat cat risk. This is primarily because most index-based contracts are treated as (re)insurance since they use also an indemnity trigger. Pure index contracts without an in-demnity trigger are treated as swaps, futures, options etc.

Under International Financial Reporting Standards (IFRS) and US GAAP, the treatment of risk transfer instruments depends on whether the instrument is classified as a reinsurance contract and thus accounted for in the technical pro-visions and the insurance result. Under IFRS, reinsurance accounting applies only to indemnity-based instruments. Under US GAAP, contracts based on a dual-trigger – ie an industry loss index and the buyer’s net loss – are treated as reinsurance. The regulatory treatment is similar. For example, ILWs and properly structured ILS receive reinsurance treatment by the National Association of Insurance Commissioners (NAIC).

In the EU, under the current Solvency I regime, the regulatory treatment of risk transfer instruments also depends on whether the instrument qualifies as a rein-surance contract. In many cases, the risk transfer instrument will be disregarded with respect to solvency capital as long as no gain is realised, ie there are no claims paid. Generally, only instruments with an indemnity trigger are treated as reinsurance. The Reinsurance Directive of 2005, which provides guidelines on the treatment of ILS transactions, further requires that the special purpose vehicle (SPV) used to transfer the risk to the capital market is established in a jurisdiction recognised by regulators as having sufficient reinsurance supervision.

These areas of the transaction process could be improved:

… investor education and risk disclosure and …

… pricing transparency.

The regulatory and accounting treatment of index-based instruments varies.

Index-based risk transfer contracts with a dual trigger are treated as reinsurance.

In the EU, generally only indemnity-based instruments are treated as reinsurance.


Future regulatory developments could lead to more adequate treatment of risk transfer and thus have a favourable impact on the use of ILS and derivatives. The proposed Solvency II regulatory framework is expected to provide solvency capital relief for all risk management and risk mitigation tools with material eco-nomic risk transfer. However, the exact details of the new rules remain open to discussion, and it is therefore too early to draw conclusions about the potential impact of Solvency II on the use of ILS and derivatives in insurance.

One potential regulatory risk arises from the scrutiny created by the recent financial crisis. ILS have generally avoided the pitfalls of irresponsible under-writing seen in the sub-prime mortgage securitisations. Nonetheless, disclosure requirements for ILS structures and their performance are expected to increase. The Obama administration has proposed a new regulatory framework for the derivatives market, subjecting it to tighter regulation and supervision in order to increase transparency and accountability and reduce counterparty risk in the financial system. The specifics of the new rules are yet to be determined, but it is likely that standardised derivatives trading would migrate to a centralised exchange or clearing house and dealers would be subject to supervision, in addition to new reporting and collateral requirements. For customised deriva-tives, timely reporting of trades to a regulated entity will likely be required. Future changes in financial regulation may create some hurdles for the ILW and cat derivatives market.

Rating agency treatment Rating agencies assess the impact of a securitisation on the financial strength

of the issuer, but there is no standard methodology and the sponsor does not always get full credit for the risk transfer. The capital credit of cat bonds to the sponsor depends on the evaluation of basis risk. Basis risk from a particular bond is often difficult to quantify with reasonable certainty, making it challenging to consistently recognise the benefits of cat risk transfer to the sponsor. For life ILS, sponsors often receive little or no capital credit for transactions that protect them under scenarios that are not contemplated in the models used by rating agencies (eg a pandemic). Developing and adopting widely accepted models and scenarios will help resolve these issues.

Solvency II is expected to provide solvency capital relief for a broader set of risk management tools.

New US financial regulations are expected to address transparency, accountability and counterparty credit risk in risk transfer transactions.

Capital credit accorded to bond sponsors by rating agencies depends on basis risk.


Market developments and outlook

Despite the innovations and progress achieved over the last few years, markets for insurance risk transfer remain relatively illiquid overall. While there is reason-able liquidity for some of the products discussed, others are rarely traded after the initial transaction. This last chapter will look at recent market developments and prospects for the different instruments.

MarketdevelopmentsandprospectsforILWs While most ILWs are not tradable securities, some standardised contracts can

be traded directly, and positions can be hedged by entering offsetting positions in the market. It is estimated that ILWs accounted for a substantial portion of the USD 7 to 12 billion volume of the combined ILW and cat derivative markets.23 ILWs have become a widely accepted tool used by investors, insurers and rein-surers to gain exposure or hedge catastrophe risk. Creation of new ILWs contin-ued during the financial turmoil and their volume is expected to grow. While ILWs have been used historically by reinsurers to obtain cover for the over-exposed portions of their portfolio, capital market investors have expanded their use of them in recent years. This trend should persist as long as demand for catastrophe capacity is strong and pricing remains attractive.

Recent efforts to create standardised documentation for ILWs in derivative form have been largely successful. Swiss Re’s SNaCSTM and the ISDA initiative are prominent examples of this.

Marketdevelopmentsandprospectsforderivatives While non-standardised contracts will remain inherently less liquid, the use of

customised OTC cat derivatives is expected to remain popular, since many cat derivatives are well-collateralised and are seen as a flexible and convenient tool to hedge relatively low notional amounts of nat cat exposure.

Although previous attempts failed, the trading of cat derivatives on exchanges has recently resumed. Liquidity on these exchanges is thus far limited, but it ap-pears that the emergence of competition from the exchanges has led to various standardisation efforts and improvements in the ILW and OTC cat derivatives markets. The IFEX cat exchange, though small, has proved to be resilient in the current market turmoil. It remains to be seen if the exchanges will become major markets for trading cat risk.

The market for mortality and longevity swaps is still in its infancy, but has the potential to grow rapidly. Since the start of 2008, seven longevity swap transactions have been completed, with mostly UK insurers and pension funds to hedge longevity risk exposure with combined reserves of USD 8.1bn (see box Birth of the longevity market). Only one of the longevity swaps was based on a life expectancy index. Recently, interest in longevity swaps among pension funds has grown as pricing has become more competitive.

23SwissReCapitalMarkets

ILW use has expanded due to improved standardisation and the increasing number of investors who act as protection sellers.

There have been successful efforts to standardise ILW derivatives.

Non-ILW OTC cat derivatives also exist.

Exchange trading of cat derivatives remains relatively illiquid.

Mortality/longevity swaps have the potential to grow rapidly …


Demand is set to increase, particularly in regulatory environments where these tools provide capital relief. The need for such capital relief is particularly strong in the UK due to both the risk-based solvency regime that was introduced in 2004, which increased capital requirements for longevity risk, and the large amount of existing longevity business. The recent Solvency II proposal to deter-mine longevity risk capital based on a 25% reduction in mortality rates may further boost demand.

Birth of the longevity market

A handful of bank/insurer longevity swap transactions have recently been com-pleted. The first publicly acknowledged longevity swap was closed in a trans-action conducted by Lucida, a UK insurance company that is focused on the annuity and longevity risk business.24 The transaction has a ten-year maturity and is based on the LifeMetrics index of mortality for England and Wales, as compiled by the ONS, the UK statistics authority. The transaction is a partial hedge for the longevity accumulated in a separate transaction executed by Lucida, in which it reinsured more than EUR 100m of the Bank of Ireland’s existing annuity business. The deal is structured in such a way that if people on the LifeMetrics index die sooner than expected, Lucida makes a payment to J.P. Morgan. And if longevity improves faster than expected, Lucida receives money from J.P. Morgan. As the market for longevity swaps develops, market participants – like pension funds or insurers that offer annuities – will find them-selves able to add longevity to the list of risks (eg interest rates, inflation etc) for which a hedge is available.

Table6: Major longevity swap transactions in 2008 and 2009

Date Insurer Counterparty USDm Index-basedFeb08 Lucida* J.P.Morgan 148 yesOct08 CanadaLife(UK) J.P.Morgan 844 noDec08 AustralianInsurer** SwissRe 352 noTotal 2008 1 344 Feb09 AbbeyLife PacificLifeReandanotherunknownRe 2162 noMar09 NorwichUnion PartnerReandRBS 686 noMay09 BabcockInternationalpensionfund CreditSuisse&PacificLifeRe 764 noJul09 RSApensionfund*** RothesayLife(GoldmanSachs)&PacificLifeRe 3099 noTotal 2009 ytd 6 711

* TransactionpartiallyhedgesBankofIreland’sEUR100mannuityblockwhichLucidareinsured.** ThisistheonlyAustraliantransaction;therestareUKtransactions.*** Assetandlongevityswap.PacificLifeRereinsureda“significantproportion”ofthelongevityriskassumedbyRothesayLife25.

Source:SwissReEconomicResearch&Consulting

24Lucida(2008).“UKlongevityswapmarksfirststeps,TOTALderivatives,20February”,availableatwww.lucidaplc.com

25Source:PacificLifeRe(2009).“PacificLifeReActsasReinsurertoRothesayLifeinBiggestEverPensionBuy-InDeal,15July”,availableatwww.pacificlifere.com

… particularly in the United Kingdom.

Longevity swap transactions have been completed.



While the market for listed catastrophe derivatives is still in its infancy, exchange- traded temperature derivatives have become fairly standard instruments. The Chicago Mercantile Exchange (CME) introduced cash-settled futures and futures options on temperature indices for ten US cities in 1999. Currently, the CME trades futures and futures options on temperature indices for 45 cities worldwide.

The weather risk market experienced robust growth in 2007/2008 before trad-ing volumes ebbed in 2008/2009 due to the financial crisis (see Figure 8).26 Trades on the CME accounted for the bulk of total trading activity. OTC trading activity has diminished significantly over the last few years and become insignif-icant relative to exchange trading.

0

10

20

30

40

50

CMEOTC

2008/092006/072004/052002/032000/01

in USD bn

Source: PricewaterhouseCoopers “2009 Weather Risk Derivative Survey”.

North America remains the main driver of the weather derivatives market, though Europe and Asia have grown to become significant players in the OTC market. The weather market continues to expand in India, Latin America and Southeast Asia, as companies seek to offset weather risks in agriculture and other sectors. Participants in the market include insurance companies, banks and hedge funds, as well as end-user businesses.

26 The spike in 2005/2006 was the result of anomalous conditions resulting from the rapid entry and exit of several hedge funds, as well as increased trading after the Katrina, Rita and Wilma hurricanes of 2005.

There is a fairly liquid market for exchange-traded weather derivatives.

The weather derivatives market has experienced robust growth over the last few years.

Figure 8: Notional value of weather risk contracts

Geographical coverage of weather derivatives is expanding.


Although temperature swaps and options are the mainstay of the OTC weather derivative market, other forms of weather risk protection, such as instruments linked to humidity or wind measures, are also available. Liquidity in these seg-ments is, however, very limited.

Supported by both demand and supply side forces, the growth prospects for the weather derivatives market remain strong. Weather-based instruments are rela-tively easy for investors to understand, and triggers are objective and transpar-ent. Moral hazard is also a non-issue. Meanwhile, exposure to losses associated with adverse weather conditions is vast and growing due to climate change. A report from CME and the Storm Exchange showed that only 10% of several hundred businesses surveyed have opted to use derivatives to manage their weather risk exposures, even though a majority of firms cite weather conditions as a factor that can influence their earnings performance.27 The market for weather-based instruments is therefore expected to continue to grow rapidly in the US and Europe, and gain importance in Asia and Latin America, as more companies and farming communities seek to offset weather risks in utilities, construction, agriculture and other sectors.

One key market development is the energy sector’s growing demand for “quanto” contracts that link weather to an energy commodity. These contracts can lock in the right to buy power at a particular price if the weather turns unusually cold. Covering commodity price and weather risks simultaneously, quantos hedge exposure to energy prices, which typically soar during a cold snap. Quanto products are commonly used by Australian, European and North American utility companies, as well as by agribusinesses.

There is also increasing demand for structures related to renewable energy, such as wind. This is due to the power companies’ shift of production from thermal to renewable energy sources.

Market developments and prospects for securitisations Issuance of total insurance-linked securities (both P&C and life bonds) reached a

record high of USD 14bn in 2007, before slowing to USD 3bn in 2008. The total outstanding volume of ILS was USD 37bn at the end of 2008, up from about USD 11bn five years earlier. Roughly half of the total ILS capacity was issued in 2006 and 2007. It appears that – even in times of softening reinsurance prices and widely available capacity – ILS have become important tools for cedents.

27 Joanne Morrison (2009). “Managing Weather Risk: Will Derivatives Use Rise?” Futures Industry, January/February.

Liquidity in more exotic weather derivatives is very limited.

The use of weather-based instruments is expected to grow rapidly.

Promising market developments include energy sector demand for “quanto” products…

…and increasing demand for structures related to renewable energy.

ILS have become important tools for cedents.



After growing vigorously between 2005 and 2007 – particularly after Hurricane Katrina – the issuance of cat bonds slowed in 2008. Only 14 deals totalling USD 3bn were issued in 2008. Lower issuance appeared to be mainly caused by the market conditions after the default of Lehman Brothers in September 2008. The default revealed some vulnerabilities in the structure of some cat bonds, which have now been resolved successfully (see box The impact of the Lehman Brothers default on cat bonds). Also, parts of the traditional cat bond investor base, such as multi-strategy hedge funds, faced increasing financing difficulties and redemptions from their own clients in the second half of 2008, forcing them to sell liquid positions, including ILS. After a sluggish issuance year, the volume of total cat bonds outstanding at the end of 2008 amounted to USD 14bn, down from USD 16bn at the end of 2007. In the first seven months of 2009, 11 cat bonds with a total notional amount of USD 1.7bn were issued (see Table 8 in the appendix and Figure 9 below).

0

5

10

15

20

Outstanding from previous yearsNew issues

2009*20082007200620052004200320022001200019991998

in USD bn

* January – 22 July 2009


Despite the problems that a few individual cat bonds faced after the demise of Lehman Brothers, the cat bond market as a whole has weathered the financial crisis well thus far.

In addition, secondary market trading of cat bonds was very active despite the turbulence, contrasting sharply with the sudden drop in liquidity of other asset classes. Swiss Re traded approximately USD 2.25bn in ILS (including life bonds) during 2008, up about 13% from 2007.28

28 Swiss Re estimates it has a 30% share of the ILS trading market.

Issuance of cat bonds slowed in 2008.

Figure 9: P&C bonds – new issues and outstanding amounts

In general, the cat bond market has weathered the financial turmoil...

… with liquidity holding up well.


Several developments highlight the fact that the cat bond market has become a mature and well established market. Structuring costs have been lowered through “shelf ” offerings. These programmes are structured in such a way that all the legal, modelling, rating and other structuring costs are done for a very large bond issue. However, not all of the bond capacity is issued initially; some “sits on the shelf ” and is issued whenever the capacity is needed by the protec-tion buyer and the market is willing to absorb the extra risk. After the initial bond issue, subsequent issues are released without additional structuring cost, lower-ing the cost of issuance and, more importantly, reducing the time between a decision to access the market and closing. New shelf offerings and takedowns from existing shelf offerings accounted for 21 of 27 issuances and more than 70% of cat risk capital issued during 2007.29

The largest proportion of bonds outstanding are for multiple perils. In 2007 and 2008, almost half of total issuance covered multiple perils. Also, cover has now been extended to new perils beyond the peak Florida wind risk that was typical in the market following hurricanes Katrina, Rita and Wilma. One bond, for exam-ple, now covers European earthquake risk in Turkey, Greece, Israel, Cyprus and Portugal, while another covers Japanese typhoon risk.

Whereas indemnity-based transactions accounted for the majority of cat bond capacity issued during the early years of the cat bonds market (1997–1999), index-based transactions subsequently gained in importance (see Figure 10). Over the last two years, however, the share of indemnity-based cat bonds issued has increased again at the expense of pure parametric indices. In 2007–2008, 36% of total cat bond capacity issued was based on indemnity triggers. This is partially due to a few large issuances by very established, and thus more trans-parent personal lines insurers. Another likely reason for the recent popularity of indemnity triggers is the abundance of capital from investors seeking investment opportunities in the run-up to the credit crisis. This favoured sponsors, as they had more leverage to drive terms and conditions. In several cases, sponsors took advantage of this enhanced bargaining power to purchase indemnity protection. However, sponsors do not always prefer indemnity triggers, even if investors are willing to accept them. From a sponsor’s perspective, the main disadvantages of indemnity transactions are higher risk spread premiums, more challenging disclosure requirements, the generally longer time required to complete indemnity transactions and the lost time value of money during the loss development period relative to a more immediate recovery in an index-based deal.

29 Guy Carpenter Securities: “The Catastrophe Bond Market at Year-End 2007”.

Structuring costs have been lowered through “shelf ” offerings.

Increasingly, new and multiple perils are covered.

Acceptance of indemnity triggers appears to have increased.



0% 20% 40% 60% 80% 100%

Various

Pure parametric

Parametric index

Modelled loss

Industry index

Indemnity

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008


Both the investor and issuer bases have expanded substantially since ILS were first issued. Whereas in the initial stages, insurers and reinsurers absorbed more than half of the ILS capacity issued, they now play a very minor role as investors (less than 10%). Instead, capital market investors now dominate the ILS investor base. Funds dedicated to this sector and money managers now account for 46% and 23% of ILS investments respectively. Banks have also increased their share. Multi-strategy hedge fund participation is currently less than in recent years (down to 14% from 31% in 2007) as many of these institutions have come under pressure during the credit crisis. Issuers have grown to include not only more primary insurers, but also corporations. In October 2007, for example, East Japan Railway sponsored Midori Ltd, a USD 260m transaction providing protection against Japanese earthquakes.

Money manager 30%

Hedge fund 5%

Dedicated cat fund 5%

Bank 5%

Reinsurer 25%

Primary insurer 30%

Money manager 23%

Hedge fund 14%

Dedicated cat fund 46%

Bank 9%

Reinsurer 5%

Primary insurer 3%

1999 2009


Figure 10: Cat bond issuance by trigger type

Both the investor and issuer bases have expanded.

Figure 11: Investor base in 1999 and 2009


Despite the temporary setback following the failure of Lehman, prospects for P&C cat bond issuance are increasingly promising. Many investors have come to accept that although the cat bond market is not subject to any fundamental credit risk or moral hazard issues, it is in need of greater transparency and tighter collateral requirements. Many of the recent deals have used total return swaps with government-guaranteed collateral, a structure that appeals to both investors and issuers. Once financial market uncertainty dissipates, new issuance is ex-pected to rebound and resume growth. Over the long term, the market is poised to grow robustly, as aggregate worldwide catastrophe risk exposure continues to increase.

Five years ago, cat bonds provided USD 4bn of capacity, which was equivalent to about 4% of the traditional capacity provided in the natural catastrophe rein-surance market. To date, the volume of outstanding cat bonds is USD 14bn. Together with an estimated market volume of roughly USD 10bn for ILWs and cat derivatives, this amounts to USD 24bn or 12% of the aggregate global cat reinsurance capacity.

Within the next ten years, the global cat capacity is expected to roughly double to about USD 410bn. If the share of capital markets remains unchanged, that would lead to an overall volume of USD 48bn for cat bonds, ILWs and derivatives. The recent documentation standardisation efforts and the more favourable ac-counting and regulatory treatment could lead to a further increase in the share of capital market capacity. Capital market instruments could also get a further boost from the newly created European market loss index. While overall European cat exposures broadly match those in the US, the cat bond, ILW and derivatives markets are currently heavily focused on US risks. There is therefore ample po-tential for more European insurance risks to be transferred directly to the capital markets. If the penetration of capital market instruments doubles, the total market volume for cat bonds, ILWs and derivatives could reach USD 96bn in ten years.

USD bn 2004 2009 2019 2019Global cat reinsurance covers 112 205 410 410Outstanding cat bonds, ILWs and cat derivatives 4 24 48 96 Cat bonds 4 14 28 56 ILWs and cat derivatives 10 20 40As a % of traditional capacity 4% 12% 12% 23%Compared to 2009 same double penetration penetration

Note: The projections assume that cat bonds grow at the same rate as ILWs and cat derivatives.


The prospects for P&C bond issuance are increasingly promising.

ILS and related instruments account for about 12% of global cat reinsurance capacity, up from 4% five years ago.

Long-term market prospects look promising.

Table 7: Market potential estimates for cat bonds, cat derivatives and ILWs



Securitisations of extreme mortality risk will continue to expand as more large global life insurers and reinsurers adopt these tools to hedge exposure to pan-demic risk. The combined volume of extreme mortality bonds issued so far is USD 2.2bn, which is minuscule compared to the face amount of mortality risk insured globally. It is difficult to estimate precisely the market potential for this type of securitisation because it refers only to extreme mortality, but it will likely fall in the range of USD 5–20bn by 2019. Mortality securitisations are simpler than other life securitisations, and investors are more comfortable with the un-derlying insurance risk. Similar to P&C bonds, the major challenges will be related to improving transparency and the quality of the collateral in order to alleviate investors’ concerns about counterparty risk. It is also possible that collateralised index-based derivatives become a more widely used tool to transfer extreme mortality risk to the capital markets.

Securitisation of longevity risk has the potential to offer a new way to manage and trade this risk, but the prospects of creating a longevity securitisation market are uncertain. This is a challenge because longevity risk is systematic and of long duration. The market needs transparent and flexible indices and benchmarks to minimise basis risk. Also, counterparty and liquidity issues must be addressed, so that investors have assurances that they will not be locked into 30 to 40-year contracts.

Although it is unclear what types of longevity risk transfer will prove successful in the future, a longevity market will likely develop and grow along with the ageing population. Governments can promote the creation of an efficient mar-ket by issuing long-term bonds to allow proper duration-matching and asset- liability management for the collateral structures that would be needed to back such deals.30

30 See sigma No 4/2008, “Innovative ways of financing retirement” for a detailed discussion.

Extreme mortality securitisations will increase with pandemic concerns.

The future of longevity securitisations remains uncertain.

Support from governments could facilitate the creation of a longevity bond market.


Appendix

Table 8: P&C insurance and extreme mortality securitisations since 2007, excluding private placements

RatingSponsor SPV Issue date Maturity date Size m S&P Moody’s Trigger PerilACE Calabash Re II

Class A101/03/2007 01/08/2010 USD 100.00 BB N/A Modelled loss US wind

ACE Calabash Re II Class D1

01/03/2007 01/08/2010 USD 50.00 B+ N/A Modelled loss US earthquake

ACE Calabash Re II Class E1

01/03/2007 01/08/2010 USD 100.00 BB N/A Modelled loss Multiperil

Swiss Re Vita III Class A-IV 01/11/2007 01/01/2011 USD 100.00 AAA Aaa N/A Extreme mortality

Swiss Re Vita III Class A-V 01/11/2007 01/01/2012 USD 100.00 AAA Aaa N/A Extreme mortality

Swiss Re Vita III Class A-VI 01/11/2007 01/01/2011 EUR 55.00 AAA Aaa N/A Extreme mortality

Swiss Re Vita III Class A-VII 01/11/2007 01/01/2012 EUR 100.00 AA- Aa2 N/A Extreme mortality

Swiss Re Vita III Class B-V 01/11/2007 01/01/2012 USD 50.00 AAA Aaa N/A Extreme mortality

Swiss Re Vita III Class B-VI 01/11/2007 01/01/2011 EUR 55.00 AAA Aaa N/A Extreme mortality

Swiss Re Australis Series II 03/14/2007 03/24/2009 USD 50.00 BB N/A Parametric index

Multiperil

Allianz Blue Wings Class A 04/03/2007 01/12/2009 USD 150.00 BB+ N/A Various MultiperilAspen Re Ajax Re 04/25/2007 05/08/2009 USD 100.00 BB N/A Industry index California

earthquakeChubb East Lane Re Class A 04/30/2007 05/06/2011 USD 135.00 BB+ N/A Indemnity US windChubb East Lane Re Class B 04/30/2007 05/06/2011 USD 115.00 BB+ N/A Indemnity US windMunich Re Carillon Class E 05/08/2007 01/10/2011 USD 150.00 B N/A Industry index US windTravelers Longpoint Re 05/08/2007 05/08/2010 USD 500.00 BB+ N/A Industry index US windSwiss Re Successor II Class A II 05/10/2007 05/10/2008 USD 100.00 B B3 Various MultiperilMSI AKIBARE Class A 05/14/2007 05/22/2012 USD 90.00 BB+ N/A Parametric

indexJapan typhoon

MSI AKIBARE Class B 05/14/2007

05/22/2012 USD 30.00 BB+ N/A Parametric index

Japan typhoon

Nephila Gamut Reinsurance Class A

05/29/2007 01/31/2010 USD 60.00 A- Aa3 Various Multiperil

Nephila Gamut Reinsurance Class B

05/29/2007 01/31/2010 USD 120.00 BBB- Baa3 Various Multiperil

Nephila Gamut Reinsurance Class C

05/29/2007 01/31/2010 USD 60.00 BB- Ba3 Various Multiperil

Nephila Gamut Reinsurance Class D

05/29/2007 01/31/2010 USD 25.00 N/A N/A Various Multiperil

Nephila Gamut Reinsurance Class E

05/29/2007 01/31/2010 USD 45.00 N/A N/A Various Multiperil

Swiss Re MedQuake Class A 05/31/2007 05/31/2010 USD 50.00 BB- N/A Parametric index

Multiperil

Swiss Re MedQuake Class B 05/31/2007 05/31/2010 USD 50.00 B N/A Parametric index

Multiperil

Liberty Mutual Mystic Re II 05/31/2007 06/07/2011 USD 150.00 B+ N/A Industry index US windUSAA Residential Re 2007

Class 105/31/2007 06/07/2010 USD 145.00 BB N/A Indemnity Multiperil

USAA Residential Re 2007 Class 2

05/31/2007 06/07/2010 USD 125.00 B N/A Indemnity Multiperil




Appendix

RatingSponsor SPV Issue date Maturity date Size m S&P Moody’s Trigger PerilUSAA Residential Re 2007

Class 405/31/2007 06/07/2010 USD 155.00 B+ N/A Indemnity Multiperil


05/31/2007 06/07/2010 USD 100.00 BB+ N/A Indemnity Multiperil

Glacier Re Nelson Re 06/11/2007 06/21/2010 USD 75.00 B N/A Various MultiperilAllstate Willow Re 06/14/2007 06/16/2010 USD 250.00 BB+ N/A Industry index US windSwiss Re (for undisclosed third party)

Spinnaker Series 2007-1

06/15/2007

06/15/2008

USD 200.00

N/A

B1

Industry index

US wind

Brit Insurance Fremantle Series A 06/21/2007 06/28/2010 USD 60.00 N/A Aa1 Various MultiperilBrit Insurance Fremantle Series B 06/21/2007 06/28/2010 USD 60.00 N/A A3 Various MultiperilBrit Insurance Fremantle Series C 06/21/2007 06/28/2010 USD 80.00 N/A Ba2 Various MultiperilSwiss Re (for undisclosed third party)


06/22/2007

06/20/2008

USD 130.20

N/A

Ba2

Industry index

US wind

Kyoei Fire and Marine/ FONDEN

Fusion 2007 Class A

06/25/2007

05/19/2009

USD 30.00

B

N/A

Parametric index

Multiperil

Kyoei Fire and Marine/ FONDEN

Fusion 2007 Class B

06/25/2007

05/19/2009

USD 80.00

B

N/A

Parametric index

Multiperil

FONDEN Fusion 2007 Class C 06/25/2007 05/19/2009 USD 30.00 BB+ N/A Parametric index

Mexico earthquake

State Farm Merna Reinsurance Series A

07/03/2007 07/07/2010 USD 256.00 N/A Aa2 Indemnity Multiperil

State Farm Merna Reinsurance Series B

07/03/2007 07/07/2010 USD 706.00 N/A A2 Indemnity Multiperil

State Farm Merna Reinsurance Series C

07/03/2007 07/07/2010 USD 176.00 N/A Baa2 Indemnity Multiperil

AXA FCC SPARC 2007 Class A

07/05/2007 07/15/2013 EUR 91.50 AAA N/A N/A Auto

AXA FCC SPARC 2007 Class B

07/05/2007 07/15/2013 EUR 220.00 A N/A N/A Auto

AXA FCC SPARC 2007 Class C

07/05/2007 07/15/2013 EUR 100.10 BBB- N/A N/A Auto

AXA FCC SPARC 2007 Class D

07/05/2007 07/15/2010 EUR 39.20 BB N/A N/A Auto

Arrow Re Javelin Re Series A 07/18/2007 07/25/2008 USD 94.50 A- N/A Indemnity MultiperilArrow Re Javelin Re Series B 07/18/2007 07/25/2008 USD 30.75 BBB- N/A Indemnity MultiperilSwiss Re (for undisclosed third party)


07/20/2007

07/09/2008

USD 50.00

N/A

N/A

Industry index

US wind

East Japan Railway Company

Midori

10/15/2007

10/24/2012

USD 260.00

BB+

N/A

Pure parametric

Japan earthquake

Allianz Blue Fin Class A 11/07/2007 04/10/2012 EUR 155.00 BB+ N/A Parametric index

Euro wind

Allianz Blue Fin Class B 11/07/2007 04/10/2012 USD 65.00 BB+ N/A Parametric index

Euro wind

SCOR Atlas Re IV 11/29/2007 01/10/2011 EUR 160.00 B N/A Modelled loss MultiperilCatlin Newton Re 2007

Class A12/17/2007 12/24/2010 USD 87.50 BB+ N/A Industry index US

earthquakeCatlin Newton Re 2007

Class B12/17/2007 12/24/2010 USD 137.50 BB N/A Industry index US wind

SRFP GLOBECAT Series CAQ Class A-1

12/21/2007 01/02/2013 USD 20.00 N/A B1 Industry index California earthquake

SRFP GLOBECAT Series LAQ Class A-1

12/21/2007 12/30/2008 USD 25.00 N/A Ba3 Modelled loss Other


RatingSponsor SPV Issue date Maturity date Size m S&P Moody’s Trigger PerilSRFP GLOBECAT Series USW

Class A-112/21/2007 01/02/2013 USD 40.00 N/A B3 Industry index US wind

Groupama Green Valley 12/27/2007 01/10/2011 EUR 200.00 BB+ N/A Parametric index

Euro wind

Swiss Re Successor Hurricane Industry Class C-VI

12/28/2007 01/05/2010 USD 30.00 B B2 Industry index US wind

Swiss Re Successor Hurricane Industry Class D-VI

12/28/2007 01/05/2010 USD 30.00 B N/A Industry index US wind

Swiss Re Successor II Class C-III 12/28/2007 04/06/2010 USD 50.00 N/A N/A Various MultiperilSwiss Re Successor II Class E-III 12/28/2007 04/06/2010 USD 50.00 N/A N/A Various MultiperilSwiss Re (for undisclosed third party)

Redwood X Class A

12/31/2007

01/09/2009

USD 25.00

N/A

Baa3

Parametric index

California earthquake

Swiss Re (for undisclosed third party)

Redwood X Class B

12/31/2007

01/09/2009

USD 227.70

N/A

Ba2

Parametric index



Redwood X Class C

12/31/2007

01/09/2009

USD 50.20

N/A

Ba3

Parametric index



Redwood X Class D

12/31/2007

01/09/2009

USD 130.50

N/A

Ba3

Industry index



Redwood X Class E

12/31/2007

01/09/2009

USD 45.20

N/A

B2

Industry index



Redwood X Class F

12/31/2007

01/09/2009

USD 20.00

N/A

N/A

Industry index


Munich Re Nathan Series 1 Class A

02/19/2008 01/15/2013 USD 100.00 A- A2 N/A Extreme mortality

Catlin Newton Re 2008 Class A

02/21/2008 01/07/2011 USD 150.00 BB N/A Indemnity Multiperil

Munich Re Queen Street Series 1 Class A

03/14/2008 03/21/2011 EUR 70.00 BB+ N/A Parametric index

Euro wind

Munich Re Queen Street Series 1 Class B

03/14/2008 03/21/2011 EUR 100.00 B N/A Parametric index

Euro wind

Chubb East Lane Re II Class A 03/31/2008 04/07/2011 USD 75.00 BB N/A Indemnity MultiperilChubb East Lane Re II Class B 03/31/2008 04/07/2011 USD 70.00 BB N/A Indemnity MultiperilChubb East Lane Re II Class C 03/31/2008 04/07/2011 USD 55.00 B- N/A Indemnity MultiperilZenkyoren Muteki 05/14/2008 05/24/2011 USD 300.00 N/A Ba2 Parametric

indexJapan earthquake

Homewise Mangrove Re Class A 05/30/2008 06/05/2009 USD 150.00 N/A Ba2 Indemnity US windHomewise Mangrove Re Class B 05/30/2008 06/05/2009 USD 60.00 N/A B1 Indemnity US windUSAA Residential Re 2008

Class 105/30/2008 06/06/2011 USD 125.00 BB N/A Indemnity Multiperil




05/30/2008 06/06/2011 USD 100.00 BB+ N/A Indemnity Multiperil

Flagstone Re Valais Re Class A 05/30/2008 06/06/2011 USD 64.00 N/A Ba2 Indemnity MultiperilFlagstone Re Valais Re Class C 05/30/2008 06/06/2011 USD 40.00 N/A B3 Indemnity MultiperilGlacier Re Nelson Re Class G 06/06/2008 06/06/2011 USD 67.50 N/A B3 Indemnity MultiperilGlacier Re Nelson Re Class H 06/06/2008 06/06/2011 USD 45.00 N/A B3 Indemnity Euro windGlacier Re Nelson Re Class I 06/06/2008 06/06/2011 USD 67.50 N/A B2 Indemnity Euro windAllstate Willow Re 2008 06/17/2008 06/17/2011 USD 250.00 BB+ N/A Industry index US windNationwide Mutual

Caelus Re 06/25/2008 06/07/2011 USD 250.00 BB+ N/A Indemnity Multiperil

Swiss Re Vega Capital Class A 06/27/2008 06/24/2011 USD 21.00 A- A3 Various Multiperil


Appendix

RatingSponsor SPV Issue date Maturity date Size m S&P Moody’s Trigger PerilSwiss Re Vega Capital Class B 06/27/2008 06/24/2011 USD 22.50 BBB Baa2 Various MultiperilSwiss Re Vega Capital Class C 06/27/2008 06/24/2011 USD 63.90 N/A Ba3 Various MultiperilSwiss Re Vega Capital Class D 06/27/2008 06/24/2011 USD 42.60 N/A N/A Various MultiperilAllianz Blue Coast Class A 07/28/2008 12/08/2010 USD 70.00 BB- N/A Industry index US windAllianz Blue Coast Class B 07/28/2008 12/08/2010 USD 30.00 B+ N/A Industry index US windAllianz Blue Coast Class C 07/28/2008 12/08/2010 USD 20.00 B- N/A Industry index US windPlatinum Topiary Capital 08/01/2008 08/05/2011 USD 200.00 BB+ N/A Various MultiperilSCOR Atlas Re V Class 1 02/19/2009 02/24/2012 USD 50.00 B+ N/A Industry index MultiperilSCOR Atlas Re V Class 2 02/19/2009 02/24/2012 USD 100.00 B+ N/A Industry index MultiperilSCOR Atlas Re V Class 3 02/19/2009 02/24/2012 USD 50.00 B N/A Industry index MultiperilChubb East Lane Re III 03/10/2009 03/16/2012 USD 150.00 BB N/A Indemnity US windLiberty Mutual Mystic Re II 2009-1 03/13/2009 03/20/2012 USD 225.00 BB N/A Industry index MultiperilAllianz Blue Fin II Class A 04/16/2009 04/16/2012 USD 180.00 BB- N/A Modelled loss MultiperilSwiss Re Successor II Series IV

Class F04/28/2009 05/06/2010 USD 60.00 N/A N/A Various Multiperil

Assurant Ibis Re Class A 05/05/2009 05/10/2012 USD 75.00 BB N/A Industry index US windAssurant Ibis Re Class B 05/05/2009 05/10/2012 USD 75.00 BB- N/A Industry index US windUSAA Residential Re 2009

Class 105/28/2009 06/06/2012 USD 70.00 BB- N/A Indemnity Multiperil


05/28/2009 06/06/2012 USD 60.00 B- N/A Indemnity Multiperil


05/28/2009 06/06/2012 USD 120.00 BB- N/A Indemnity Multiperil

Munich Re Ianus 06/09/2009 06/09/2012 EUR 50.00 N/A B2 Various MultiperilACE Calabash Re III Class A

Series 2009-106/10/2009 06/15/2012 USD 86.00 BB- N/A MITT* Multiperil

ACE Calabash Re III Class B Series 2009-1

06/10/2009 06/15/2012 USD 14.00 BB+ N/A MITT* US earthquake

NC JUA/IUA Parkton Re 07/28/2009 05/06/2011 USD 200.00 B+ Indemnity US windHannover Re Eurus II 07/29/2009 04/06/2012 EUR 150.00 BB N/A Parametric

indexEuro wind

* Modeled Industry Trigger Transaction Source: Swiss Re Capital Markets

Recent sigma publications

No 4/2009 The role of indices in transferring insurance risks to the capital markets

No 3/2009 World insurance in 2008: life premiums fall in the industrialised countries – strong growth in the emerging economies

No 2/2009 Natural catastrophes and man-made disasters in 2008: North America and Asia suffer heavy losses

No 1/2009 Scenario analysis in insurance

No 5/2008 Insurance in the emerging markets: overview and prospects for Islamic insurance

No 4/2008 Innovative ways of financing retirement

No 3/2008 World insurance in 2007: emerging markets leading the way

No 2/2008 Non-life claims reserving: improving on a strategic challenge

No 1/2008 Natural catastrophes and man-made disasters in 2007: high losses in Europe

No 6/2007 To your health: diagnosing the state of healthcare and the global private medical insurance industry

No 5/2007 Bancassurance: emerging trends, opportunities and challenges

No 4/2007 World insurance in 2006: premiums came back to “life”

No 3/2007 Annuities: a private solution to longevity risk

No 2/2007 Natural catastrophes and man-made disasters in 2006: low insured losses

No 1/2007 Insurance in emerging markets: sound development; greenfield for agricultural insurance

No 7/2006 Securitization – new opportunities for insurers and investors

No 6/2006 Credit and surety: solidifying commitments

No 5/2006 World insurance in 2005: moderate premium growth, attractive profitability

No 4/2006 Solvency II: an integrated risk approach for European insurers

No 3/2006 Measuring underwriting profitability of the non-life insurance industry

No 2/2006 Natural catastrophes and man-made disasters 2005: high earthquake casualties, new dimension in windstorm losses

No 1/2006 Getting together: globals take the lead in life insurance M & A

No 5/2005 Insurance in emerging markets: focus on liability developments

No 4/2005 Innovating to insure the uninsurable

No 3/2005 Insurersʼ cost of capital and economic value creation: principles and practical implications

No 2/2005 World insurance 2004: growing premiums and stronger balance sheets

No 1/2005 Natural catastrophes and man-made disasters in 2004: more than 300 000 fatalities, record insured losses

No 7/2004 The impact of IFRS on the insurance industry

No 6/2004 The economics of liability losses – insuring a moving target

No 5/2004 Exploiting the growth potential of emerging insurance markets – China and India in the spotlight

No 4/2004 Mortality protection: the core of life

No 3/2004 World insurance 2003: insurance industry on the road to recovery

No 2/2004 Commercial insurance and reinsurance brokerage – love thy middleman

No 1/2004 Natural catastrophes and man-made disasters in 2003: many fatalities, comparatively moderate insured losses

Swiss Reinsurance Company LtdEconomic Research & ConsultingMythenquai 50/60P.O. Box8022 ZurichSwitzerland

Telephone +41 43 285 2551Fax +41 43 285 [email protected]