“How does the Insurance Securities (ILS) Market digest the current Demand?”

Presentation to the CFA Society Switzerland 22 nd October 2013

For professional/qualified investors use only, 22 nd October 2013

Contents

ILS Market Overview Recent observations ILS investing, underwriting (information asymmetry) Market outlook Conclusions

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ILS Market Overview

Terminology

Term

ILS Broker Limit, line, capacity Premium Rate on Line (ROL) Private ILS IBNR ILW

Explanation

Insurance linked securities, refers to tradable (cat bonds) and less tradable (collateralized reinsurance) investments. In the latter case, preferred shares of the cell company are the securities (private ILS) «Reinsurance broker», an intermediary between insurance and reinsurance or reinsurance and retrocessionaire; i.e. not an execution broker The dollar amount «traded» between counterparties, i.e. the protection sold/purchased (principal) The dollar amount owed to Not a delta to a reference rate (e.g. CAPM) the protection seller for the capacity.

Premium expressed in relation to the limit, first indication of return on investment (excluding time value of money or cash flow considerations) ILS Transactions which are agreed between two parties. Fully collateralized, investor owns shares of a protected cell company or notes of a private cat bond Incurred but not reported; an estimate of the liability for claim-generating events that have taken place but have not yet been reported to the insurer. The sum of IBNR losses plus incurred losses provides an estimate of the total eventual liabilities for losses during a given period Industry loss warranty, a transaction type which uses as trigger mechanism any industry wide loss information. The protection buyer incurs basis risk as the payout of the transaction is not directly linked to its suffered loss. Examples are PCS or PERILS as trigger agents 3

ILS Market Overview

Insurance Market Overview

Retrocession Broker Reinsurance Broker Primary Insurance Policyholders: (home insurance)

Risk is ceded upwards

Source: Twelve Capital. As on 30 th September 2013.

Private ILS Private ILS Cat Bonds Cat Bonds 4

ILS Market Overview

ILS Market Size

• • • • • The worldwide market for catastrophe reinsurance (the most lucrative reinsurance business) is some USD 250bn in size (pizza) • The largest chunk is still traditional reinsurance (i.e.

not collateralized), selling capacity on a credit rating The convergence market; cat bonds and collateralized reinsurance, is rapidly growing now (pizza slice) Since January 2012 some USD 5 to 6bn in new capital has entered the cat bond market, USD 3bn of which in the last 6 months only Sourcing cat bonds in the secondary market can mean entering a winners curse race 

is the pizza slice growing only or is the pizza getting larger, too?

Catastrophe limits worldwide: USD 250 billion

26 18 Traditional reinsurance Cat bonds Collateralized Reinsurance 206 Source: Guy Carpenter, Twelve Capital. As on 31 st August 2013.

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ILS Market Overview

ILS Market size: Cat Bonds Issue Volume

Outstanding Cat Bond Volume, 2003-2013

20 000 18 000 16 000 14 000 12 000 10 000 8 000 6 000 4 000 2 000 0 3 005 3 876 4 741 6 608 2003 2004 2005 2006 Source: Swiss Re Capital Markets. As of 9 th July 2013.

12 911 2007 16 155 2008 13 249 13 167 2009 2010 11 504 2011 14 923 17 513 2012 YTD 2013

Cat Bonds versus US Wind Bonds Volume since 2007

21 12% 18 15 12 10% 8% 6% 9 6 3 4% 2% Jan '07 Jul '07 Jan '08 Jul '08 Jan '09 Jul '09 Jan '10 Jul '10 Jan '11 Jul '11 Jan '12 Jul '12 Jan'13 Jul'13 Other perils US wind bonds Coupon of all cat bonds Coupon of US wind bonds 0% Source: Twelve Capital. As of 31 st July 2013.

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A Story of Marriage….

ILS Market Overview

US Wind Historical Returns

103 102 101 100 99 98 97 96 95 1

Swiss Re US Wind Price Return Index SRUSWPRC

8 15 2002-2011 22 2012 29 2013 36 • • • Cat Bonds are built on an long lasting, established reinsurance market What happens to the reinsurance market affects the smaller Cat Bond market Investors know the implications and draw conclusions 43 Source: Swiss Re. as of 13 th September 2013. 50 Week 7

ILS Market Overview

Investors Overview

12% 11%

Cat Bonds Investors Breakdown: 2007 versus 2012 Investors Snapshot 2007 Investors Snapshot 2012

7% 1% Dedicated Fund Reinsurer AM Hedge Fund Insurer Bank 4% 3% 14% 56% 17% 61% Dedicated Fund Reinsurer AM Hedge Fund Insurer Pension Funds 13% 1% • • • More “sticky” money today, more sophistication The market has become more mature The collateralized reinsurance market is also developing in that direction Source: Swiss Re Capital Markets. As od 31 st December 2012.

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ILS Market Overview

Investors Overview: Pension Funds

USD 800bn USD 45bn Pension Funds Estimated Market Potential Investment Size for Pension Funds ILS Market Size USD 20'000bn • Assumptions − 5'600 European insurances investing 4% average of their assets − Conservative estimation of the Pension Funds Market Size of USD 20tn Source: Mercer Survey as of 20 th May 2013 “European Asset Allocation Survey – LDI Strategies and Alternatives in Focus”.

Data in USD billion.

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Recent Observations

All Cat Bonds - July 2013 versus April 2012

14 12 10 8 6 4 2 0 100 200 300 400 Expected Loss (EL) in bps 500 600 700 800 All Cat Bond - Apr 2012 All Cat Bond - Jul 2013 1 Trendline - Apr 2012 1 Trendline - Jul 2013 1 Method: using the exponential trendline functionality in Excel Source: Twelve Capital.

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Recent Observations

Market Cycles by Class

Managing the Soft Market

• Comparing different underlying asset classes within the ILS market we see that different pricing cycles are observed 300 280 260 240 US Cat reinsurance Internat. Cat Reinsurance Property reinsurance Marine Hull 220 200 Offshore energy 180 160 140 120 100 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Jan 2013 Jun 2013E • Looking at a broader range of underlying insurance asset classes allows us to enter niche markets as pricing improves • During 2013 we have sourced transactions in classes where pricing has increased substantially as an after effect of losses our investors did not pay: Australia/New Zealand, US Crop, Marine 11 Source: Amlin plc. renewal rating index; June 2013 renewals estimates by Twelve Capital.

Recent Observations

Private ILS versus All Cat Bonds – July 2013

18 16 14 12 10 8 6 4 2 0 0 Private ILS - Jul 2013 All Cat Bond - Jul 2013 Trendline - Private ILS 1 Trendline - All Cat Bond 1 200 400 600 Expected Loss (EL) 800 1000 1200 1400 1 Method: using the exponential trendline functionality in Excel Source: Twelve Capital.

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Recent Observations

Examples of Recent Transactions Closed

Selected Private ILS closed in Q2 2013 Private ILS Crop Insurance Risk assumed

Agricultural crop insurance in the USA

Transaction basis

Indemnity reinsurance contract

Trigger Tenor Economics Collateral

Abnormal weather causing physical damage to crop combined with yield produced is less than estimated at the time of planting 12 months Approx. 17% annual return (5.0% EL) US T-bills

Private ILS Risk assumed Terrorism Cover

Physical damage to property due to terrorism worldwide

Transaction basis

Indemnity reinsurance contract

Trigger

Losses to underlying portfolio exceeding a certain level

Tenor

12 months

Economics Collateral

Approx. 10% annual return (3.3% EL) IBRD note

Private ILS Risk assumed Dual Trigger US Wind

Damage to oil exploration platforms due to hurricanes

Transaction basis

Swap

Trigger Tenor

Trigger 1: Hurricane Cat 3 in defined geographic location Trigger 2: Total loss of certain oil exploration platforms 6 months

Economics

Approx. 13% return (0.8% EL)

Collateral

IBRD note Transaction rationale: Transaction benefits from

increased premiums

insurance market post last in the crop year’s losses.

Source: Twelve Capital.

Transaction represents a rationale: transaction

well paying diversifier.

Transaction benefits from rationale: Transaction

attractive multiple

due to highly tailored coverage for a corporate.

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ILS investing, underwriting

Investment Process Cat Bonds

Sourcing Analysis Pricing Portfolio Construction Packaging

Process: Investment Case, Rating Framework

• − − − Each bond is analyzed according to multiple attributes, among which: Collateral structure Trigger mechanism Risk measures (loss probabilities) − Redemption features, reset mechanism

Selection of a Cat Bond

• − − −

Investment cases

form the basis for the selection of bonds. Each bond is allocated either: attractive, cautious or decline which will define the weighting in the funds: • − Diversification of bonds in the fund is key for sustainable performance. We use several levels of diversification: Perils diversification, very high  reduction of draw down risk Decline  bought these bonds will never be Cautious  market weight or underweight Attractive  PM can overweight but not more than 1% more than market − − Type of triggers, high  reduction of risk of unexpected reserve development in indemnity bonds Sponsor of bond  reduction of available bonds as retreat of sponsor reduces available securities − Attractive  Position is not larger than 2.5% of NAV of vehicle − Repurchase counterparty, high  reduction of collateral loss due to counterparty default − Number of transactions, very high  reduction of risk of unknown structural flaws 14

ILS investing, underwriting

Underwriting and Pricing

Underwriting, What is It?

• Collection of data to allow for best possible risk judgment • Analysis of data, preparation of data for analysis • Determination of risk measures (expected loss, VaR, Standard Deviation …) • Review of legal wording • Interaction with cedant and broker • Engaging in structuring and closing the transaction together with Legal Dept.

• Preparation of renewals (review data quality, close gaps, assess profitability...) 

Underwriter should have a rather good level of information of an insurance company

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Pricing a “Risk”

Expected Loss

ILS investing, underwriting

Underwriting and Pricing

Risk Loading − Profit Loading Other Loads − Stochastic − Burn − Exposure − Unmodeled − Uncertainty for modeled − Add load for profitability Determination of “known” risk premium

Technical rate

; determination of total risk premium

Net price

; determination of long-term profitability

Gross price

; Load for other transaction costs e.g. brokerage − Add load for brokerage Quote What we are offering to the broker (i.e. our price) 16

ILS investing, underwriting

Cycle management

The State of the Market: Two Fundamental Cycles drive Market Pricing over Time

• Supply and Demand of Capacity Capacity is scarce Relative Price Abundant capacity Time • Annual seasonality of windstorms in peak regions: US Hurricane, European Winter Storm, Typhoon − − Storm season forecasts affect protection buyer’s appetite and protection seller’s pricing Prices will increase after major losses as protection sellers seek

pay-back

Source: Twelve Capital.

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ILS investing, underwriting

Information asymmetry

Forms of information a symmetry…

• • Insurance is opaque: − − − Development of reserves In-depth knowhow of IBNR Premium development, acquisition costs Only bad business is given to the financial market (cession bias)

... and ways out of it

• Long tail business is not (yet) lending itself well for collateralized reinsurance • For short tail business: „submission pack“ provides in-depth information on the company at stake − − − − Due diligence  depth, data Asking the right questions is the skill...(underwriting) Renewal process is key  trust This is a „normal“ process  systematic tendency to reduce asymmetry • Reinsurers buy protection only if they have to (bias to retain) − − Luck is not skillful

Processes and systems make it almost impossible to carve out bad business

− − Underwriter decides on business Who says its bad?

 is there the right price for it?

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Outlook

Current Market Outlook

The Pricing Cycle: Where are We Today?

• • Supply and demand of capacity − − Abundant capital is available in the market However, the new capital is mostly targeting specific areas which are easiest to access and require least underwriting skill (US Wind ILWs) • Annual seasonality of windstorms in peak regions − − Recent years have been relatively loss free in peak markets despite Hurricane Sandy Pay-back pricing is available in niche markets but is difficult to access without contacts and underwriting skills

Therefore, overall pricing is softening in property lines

•

Specialty lines are either at lows but others may hold more firm

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Outlook

Current Market Outlook

What contributes to the Attractiveness….

• • • • • • Insurance is opaque for most observers (  premium, alpha?) (Re)insurance established, renewals) is rules a are market which is clear …. (trust, Returns from cat bonds are weakly correlated to financial markets (Lehman, Government yields  chart) Collateralized reinsurance is uncorrelated to financial markets “Big” events result in higher spreads, more than a promise (e.g. Katrina, Tohoku, Deepwater Horizon) Sophistication of market: we should be expecting innovation • • Chart: timeseries 31 May 2013 – 8 Sept 2013: Recent interest rates increases had a strong effect on high yield bonds (volatility!) Return -0.9% , Volatility 5.4% Twelve ILS fund was not affected at all by this Return +0.9% , Volatility 0.5% Source: Bloomberg, Twelve Capital.

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Twelve Capital ILS Strategy

Conclusions

ILS Market will grow

• Current and expected economy fosters ILS as attractive asset class • Large demand will bring supply to market • Supply/Demand meet  innovation (Pizza to grow) • Innovation  novelty premium

Asymmetry

• The size of the asymmetry hill is not insurmountable (underwriting) • Traditional reinsurance builds on trust

Attractive Market

• Risk adjusted spreads are attractive • Collateralized reinsurance for underwriters • Cyclicality provides “guarantees” to come back to par post event 21

Disclaimer

The products and services described herein are not available nor offered to US persons and may not (and will not) be publicly offered to persons residing in Switzerland, or any other country restricting the offer of such products or services.

This material has been furnished to you solely upon request and may not be reproduced or otherwise disseminated in whole or in part without prior written consent from Twelve Capital AG. The information herein may be based on estimates and may in no event be relied upon. Twelve Capital AG does not assume any liability with respect to incorrect or incomplete information (whether received from public sources or whether prepared by itself or not). This material does not constitute a prospectus, a request/offer, nor a recommendation of any kind, e.g. to buy/subscribe or sell/redeem investment instruments or to perform other transactions.

The investment instruments mentioned herein involve significant risks including the possible loss of the amount invested as described in detail in the offering memorandum(s) for these instruments which will be available upon request. Investors should understand these risks before reaching any decision with respect to these instruments.

Past performance is no indication or guarantee of future performance.

Twelve Capital AG

Dufourstrasse 101 8008 Zurich, Switzerland Phone +41 (0) 44 5000 120 [email protected] www.twelvecapital.com

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