Transcript Slide 1 - The ILS Funds

The ILS Funds
Investing in Insurance Linked
Securities – An Opportunity for
Buy Side Innovation
November 2008
Executive Summary
•
Insurance linked securities (“ILS”) have performed remarkably well - both the
historical performance and current yields of the securities make them an attractive
diversifying element of the bond and/or alternative asset portfolios of institutional
investors. High relative value, high non-correlated returns, resilience in market
downturns.
•
Developing and managing a portfolio of these securities requires a detailed
understanding of the underlying portfolio exposures and the complex models used
to measure the embedded risks. Investing in the securities requires knowledge of
insurance operations and capital management.
•
The ILS Funds have been organized to bring insurance operating experience to ILS
investing. The fund is being formed by three seasoned professionals expert in risk
modeling and capital management. Other funds seeking to enter the space are
backed by conflicted intermediaries.
•
The target is a $250 million fund, deployed over 12-24 months, providing returns of
LIBOR + 500 bps. It is organized as a closed end bond fund with two subfunds, one
investing in “life” ILS (embedded mortality and morbidity risks) and one focused in
“non-life” ILS (embedded property risks). Targeted formation date is March 1, 2009,
following the close of the 2009 reinsurance renewal season.
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$15 b of non-life ILS outstanding
In 2008, origination has slowed only slightly. New uses for ILS (e.g., facilitating transactions)
are adding to the new origination volume. Soft reinsurance pricing has not stopped ILS growh.
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$22 b of life ILS outstanding
4
Attractive Performance of the Asset Class
A basket of BB-rated ILS (SRCATTRR:IND) returned 44.0% from 11/7/2003 through 11/7/2008. This period
includes the only insurance loss yet to occur – a recovery after the Katrina – Rita – Wilma storms of 2005. A
well-regarded managed portfolio of corporate BB bonds (BHYAX:US) had negative returns over the same
period. The most recent returns have sustained this view …
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Strong but Imperfect Non-Correlation
In the six months ending 11/7/08, two market changes have affected ILS prices. First, a repudiation of risk
generally (flight to Treasuries) and of modeled risk in particular. Second, collateral quality is now a major issue
in market pricing and four ILS issues traded sharply lower due to the use of corporate paper. ILS have still
performed much better than similarly rated corporate bonds.
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Excess Spread Opportunity
Market Pricing of 127 Issues - Losses & Spread
over LIBOR
4500
Spread over LIBOR (bps)
4000
3500
3000
2500
2000
1500
1000
500
0
0
20
40
60
80
100
120
140
Est. Loss Cost (bps)
At 9-30-08 87 issues paid spreads above LIBOR >5x the expected loss costs ……
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ILS as Reinsurance
The current bid pricing can be used to calculate an expected loss ratio –
the portion of the spread over LIBOR that will ultimately be returned as
indemnification for losses. The average ILS is priced to an expected loss
ratio as follows:
ELR Imbedded in ILS Market Pricing
Annual Risk
(b.p.'s)
Premium (b.p.'s)
Implied LR
100
1,190
8%
200
1,964
10%
300
2,738
11%
400
3,512
11%
500
4,285
12%
Priced and traded as a bond, an ILS is also a limited duration, specified
and remote risk reinsurance policy. Thinking of it as reinsurance, this is
hard market pricing, and exactly the pricing environment where
successful companies get created.
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ILS as Reinsurance – Lower Operating Costs
Assembling a portfolio of cat bonds can be done without broker
commissions, the high overhead of a Bermuda office, or the risk of
adverse development in old accident years. Compared to operating
an insurance company, both loss costs and expenses are lower :
5-year Loss & Operating Expense Ratios
2007
2006
2005
2004
2003
Average
Ren Re
Loss & LAE - Reinsurance
25.2%
15.2%
132.2%
79.0%
25.9%
IPC Re
"
31.9%
14.7%
237.0%
Partner Re "
50.8%
54.8%
87.3%
65.6%
65.6%
68.1%
Comparable figure for cat bonds
11.7%
Ren Re
UW Expense
IPC Re
"
Partner Re "
19.6%
18.2%
29.6%
19.3%
17.5%
29.6%
16.5%
16.1%
18.0%
14.8%
29.0%
29.0%
27.8%
Comparable figure for ILS Fund
21.9%
2.0%
Lower operating costs lead to higher profits with less risk….
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ILS as Reinsurance – Higher Profits, Lower Risk
ILS pay a much higher return per quanta of risk. The profitability of the
spread over LIBOR is analogous to reinsurance premium, and can be used
in measures of underwriting profitability:
Underwriting
Loss Ratio Expense Ratio Total
Profitability
Reinsurer
68.1%
21.9%
90.0%
10%
ILS Portfolio
11.7%
2.0%
13.7%
86%
ILS investing is low leverage – $1 invested is $1 at risk. Reinsurers take on
over $2 of risk for every $1 of capital. Debt and “side cars” both increase
leverage and present risk returns as service fee income. The ILS Funds
will be deploying capital over the course of 2009, and will be only 30%
deployed on average. Even after this leverage, higher returns come from a
portfolio of ILS holdings:
Reinsurers
ILS Portfolio
Leverage
Post-Leverage Returns
2.00
20%
0.30
26%
A $1 of risk pays ILS investors $6.32 while reinsurers get $1.11.
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Operations expertise manages the risk
Example – Cat Bonds
Accurate measurement of the risk of loss costs requires insights that come from
operating insurance companies.
• Understanding and using geo-coded data
 Adjusting for the use of “centroid” data
• Timely and accurate “insurance-to-value”
– Correcting for historical errors
• Monitoring aggregate exposures
 A second 1000 Cape Coral residences has a different risk-return profile
than does the first
• Changes in the underlying risk portfolios
Example – Model Selection
Issuers can game model selection, so successful investing requires mastery of the
detailed data.
A real world example follows: one company’s insured exposures and the
1938 hurricane.
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One model predicts losses of $21 mm
• RMS losses concentrated on right side of storm track.
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A second model says $235 mm
• AIR distributes loss to both sides of storm track.
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Issuers can “game” model selection, so investors
must master and model the detailed data
•
•
Both RMS and AIR say they are providing the right answer


Long Island Express footprints accurately reflects reported wind speeds and damage.
Industry aggregates are within 5%, yet distribution of loss varies considerably between
models.
Sample Co. versus industry


Sample has no MA exposure, where RMS is higher for industry.
Sample has peak exposures in NJ where RMS assigns no loss.
Industry
State
RMS
AIR
% Diff
MA
$12,012,852
$3,646,699
-70%
RI
$4,373,282
$905,879
-79%
NH
$1,441,918
$654,324
-55%
CT
$1,205,071
$3,593,737
198%
ME
$439,992
$116,407
-74%
NY
$274,471
$9,786,242 3465%
VT
$16,879
$274,766 1528%
NJ
$0
$1,749,653
N/A
PA
$0
$71,915
N/A
NC
$0
$2,944
N/A
VA
$0
$1,589
N/A
MD
$0
$5,446
N/A
DE
$0
$10,528
N/A
Total $19,764,465 $20,820,129
5%
RMS
$0
$8,590
$0
$9,447
$604
$2,539
$12
$0
$0
$0
$0
$0
$0
$21,192
Sample Co.
AIR
$0
$3,169
$0
$57,828
$192
$108,389
$432
$63,998
$1,020
$0
$3
$22
$46
$235,098
% Diff
N/A
-63%
N/A
512%
-68%
4169%
3575%
N/A
N/A
N/A
N/A
N/A
N/A
1009%
Experienced insurance operators, we insist on closing with the data. This
produces better ILS investment decisions.
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Black Swans
•
Insurance linked securities are subject to model risks:
 Data integrity
 Model selection
 Scope and currency of the model
 Timeliness of the results
 Bias to action by the model user
Ignorance of the model limitations guarantees model risk, while close attention
to data and model issues minimizes the risks.
•
The insurance industry’s broader problems with coverage definition, regulatory
and rating agency risk, et al are not transferred in the securities. Counterparty
risks, systemic risks, et al are present, but minimized by the structure of the
securities.
•
ILS have one-way non-correlation – the ILS loss triggers are not caused by other
events in the capital markets. Capital market events have effected the collateral
of four of the outstanding cat bonds. The last 3 months dropped corporate
bond prices 23%, and dropped ILS prices 2.5% .
ILS are complex securities, but simpler than MBS.
Portfolio results are largely driven by non-correlated risks.
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Best Choice for Your ILS Manager
•No channel conflicts
Of the 10 funds active or forming, 7 are sponsored by brokers or reinsurers. The parent
organizations make a greater margin from traditional reinsurance, so the funds have to
make decisions accommodating unrelated business interests, and investor money is
put into sidecars and “special situations”. The ILS Funds are focused on ILS.
•Appropriate fee structure
6 of the 10 funds have PE / hedge fund style “2 and 20” management fees. The ILS Funds
charge fees appropriate to a bond fund: a 25 b.p. management fee until the money is
deployed into ILS, and 60 b.p. management fee on ILS invested funds.
•Closer to the data
Only The ILS Funds have been formed by actuaries and accountants skilled in insurance
company management, rather than brokers and consultants. The ILS Funds have the
tools and inclination to “trust, but verify”.
•Better Risk Management
8 of the 10 funds operate or will operate without systems for aggregating exposures across
securities. The ILS Funds have adapted an enterprise risk management model to the
ILS investment business, and are able to aggregate exposure information.
•Access
Broker and reinsurer funds have proprietary access to only their own transactions. The ILS
Funds are an investor attractive to all originators.
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Significant supply of new investment opportunities
Assuming future growth at half the historical
rate, the new originations increase from the
current $14b to $119b per year.
Sources of New Business
Bankers
• Goldman
• Lehman
• UBS
Pvt Placements
• Bankers
• Brokers
• Direct
Total volume outstanding is projected to
grow to over $300b, again assuming growth
at half the historical rate.
Brokers
• Benfield
• Aon
• Guy Carpenter
Reinsurers
• Swiss Re
• Munich Re
• AIG
•Swiss Re has indicated they will
provide to The ILS Funds 6-8
investment opportunities of $5-10 mm
each every 6 months.
•The total pipeline of The ILS Funds is
estimated at 2x the Swiss Re offer, or
over $200 mm per year.
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Structure of The ILS Funds
The ILS Funds
$125 mm
Non-Life Fund
• Cat Bonds
• ILWs
• Other
$125 mm
Life Fund
• XXX Bonds
• Other
Staffing
Non-Life Fund
• MA, Partner
• DB, Associate
Life Fund
• NB, Partner
• AA, Associate
Shared Resources
• PK, Partner
• PC, Associate
• GW, Analyst
• AS, Controller
Terms
• Structured as a closed
end bond fund
• Qualifying investments
limited to ILS – no
sidecars or “special
situations”
• Investors elect life / nonlife allocation
• 10 year life
• Qualifying investments
have a maximum term of
7 years, expect 3 yr avg
• Management fee of 25 bp
on uninvested funds, 60
bp on ILS invested
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Investment Process
Small, Disciplined Group
• Independent risk of loss
analysis using multiple
models and the same or
proxy data
• Comparison of returns to
target LIBOR + 500 bps
• Proforma effect on
aggregate exposure
models
• Investment committee
presentation and decision
• Call and funding
• Daily monitoring of any
developing risk issues
• Quarterly reviews of all
individual positions and
aggregate portfolio
• Quarterly reviews of price
targets
• Daily calls to discuss any
open trading orders
18-24 investment
opportunities per year
Investment
Committee
Process
Individual
Issue
Monitoring
Market
Operations
Portfolio
Level
Monitoring
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Background of the Professionals
NB, Partner, FSA
Responsible for management of the life fund, NB is a senior actuarial partner with a Big 4 accounting
firm. His background includes 20 years of actuarial consulting and 5 years of operating life, credit life
and annuity insurance companies. He has been involved in structuring and purchasing reinsurance
for the bulk of his career, and is currently responsible for the life securitizations of the nation’s largest
insurer. He will devote full time to The ILS Funds.
Preston Kavanagh, Partner, CPA
Responsible for overall management of the funds, Preston is an experienced insurance entrepreneur
who also has 10 years of experience in the operation and management of investment funds targeting
the insurance industry. His background includes 10 years with KPMG (8 years in actuarial consulting),
10 years as a partner managing the Conning Capital Funds, and 5 years operating property-casualty
insurance companies. He has been involved in structuring and purchasing reinsurance in workers
compensation, homeowners insurance, commercial specialty lines and excess and surplus lines,
including membership on the Reinsurance Security Committee of Alleghany Corporation. He
contributed to the development of the risk based capital models used by the NAIC and AM Best, and is
familiar with the risk capitalization models used by the major rating agencies. CPA, CMA, CLU, ChFC.
He will devote full time to The ILS Funds.
MA, Partner, FCAS
Responsible for management of the non-life fund, MA is the risk and reinsurance officer of a property
insurance company with 400,000 insured locations. He has been involved with insurance and
reinsurance of property risks for the bulk of his 25 year career, including 2 years spent developing one
of the leading cat models and 5 years steering the development of the other model as that company’s
beta user. He will devote full time to The ILS Funds.
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Background of the Professionals
DB, Associate
[Support for cat bond modeling, out of cat modeling firm].
AA, Associate
[Support for mortality / morbidity modeling, out of actuarial consulting firm].
GW, Analyst
[Utility infielder for investment cash flow analysis and modeling, out of NY group focused on ILS].
PC, Associate
[Support for IT and communications technology].
AS, Controller
Responsible for the day to day cash operations and reporting of The ILS Funds, AS has 8 years of
experience as the controller of the Conning Capital Funds. This involved accounting and reporting for
20 entities and 120 limited partner interests.
Investing in ILS requires expertise in insurance company data and operations,
catastrophe models, and acting on the relevant insights. Only The ILS Funds
brings the expertise without conflicts. The best choice for your ILS manager is
The ILS Funds.
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Associated Professional Firms
Milliman
Actuarial Consulting, Non-Life
Towers Perrin
Actuarial Consulting, Life
Goodwin Procter
Legal
PricewaterhouseCoopers
Audit
Innovative Computer Systems
AIR
RMS
Equecat
Technology
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Next Steps
The ILS Funds are now seeking expressions of interest. If you would like to receive
additional information, please contact [fund raising agent], at the following:
To schedule a meeting with the fund managers, please contact the following:
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