11 35am schmutz, markus

Proprietary and Exclusive

1

Alternative Risk Transfer Mechanisms Presentation to: The Annual Insurance Executive Conference

Markus Schmutz Swiss Re Capital Markets December 2013


What are Insurance Linked Securities?

2

Natural catastrophe bonds (cat bonds for short) and other types of ILS are usually issued in order to provide re-/insurance protection to insurers, reinsurers, governments, and corporations

Cat bonds allow companies to obtain reinsurance protection from a new pool of capital separate from traditional reinsurers

– Money managers, hedge funds, and pension funds represent a new pool of capital for insurers and reinsurers to gain protection from

Investor capital provides collateralized cover

– Investor capital sits in a segregated collateral account, meaning that if an event occurs, dedicated funds are available to make a payment

– This virtually eliminates the credit risk inherent in traditional re-/insurance


How do Cat Bonds work?

3

SPV

. Return of

Remaining Principal

Premium

Risk Transfer Contract

Sponsor Collateral

Trust

Investors

Note Proceeds

Stable Value Investments

Investments Directed Investments Yield

Coupon: DIY + [ ]%

1. The sponsor (the insurer or reinsurer looking to get protection) enters into a risk transfer contract (reinsurance or derivative) with a special purpose company established specifically for the transaction (SPV)

2. The SPV capitalizes itself by issuing Notes (the "Cat Bonds") to Investors in the capital markets in an amount equal to the limit of the risk transfer contract

3. Proceeds from the securities offering are transferred into a collateral trust account and invested to provide a stable return

4. If no covered event occurs during the risk period the bonds will be redeemed at 100% of face value. In case of a covered event meeting the thresholds set forth in the risk transfer contract, funds will be withdrawn from the collateral account to make an event payment to the sponsor. The redemption price of the bonds is reduced accordingly

1 2

3


How ILS emerged

4

In 1992, Hurricane Andrew made landfall in Florida causing $15.5b in insured losses

The resulting shortage of reinsurance capacity prompted reinsurers, banks, and academics to investigate new ways of transferring catastrophe risk outside the traditional reinsurance capital pool

In 1997, Residential Re, the first catastrophe bond was sold to capital markets investors, protecting USAA against the risk of a major hurricane

Since then, approximately $54 billion of cat bonds have been issued, providing protection to over 80 insurers, reinsurers, governments, and corporations for a multitude of risks


ILS Universe

5

Currently $19.8 billion in cat bonds are outstanding, with an estimated $28 billion in other private non-life risk transfer to capital markets investors

Swiss Re has issued approximately $2.2 billion in Vita extreme mortality bonds since 2003. Post financial crisis, the embedded value and life settlement markets have slowed considerably

Catastrophe Bonds

Catastrophe Derivatives/ Industry Loss Warranties

Collateralized reinsurance/retro

Quota Shares/Sidecars

Non-Life

Extreme Mortality Bonds

Longevity swaps/bonds

Embedded Value Securitizations

Life Settlement Securitizations

Reserve Financing (e.g. Reg XXX)

Life


Cat bond issuance and outstanding (USD bn)

Global cat bond market reaches all time high

6

Source: Swiss Re Capital Markets;

2013 will become the second largest issuance year in history

28 deals YTD, pushing total volume outstanding to approximately USD 20bn, largest year end total on record

Repeat sponsors driving growth, taking advantage of low spreads and structural innovations

Since 2011, outstanding Cat Bond market has grown by approx. USD 6bn with new sponsors accounting for USD 2bn of the growth

Investor demand continues to outweigh supply

2013 new issuance volume is second largest ever; market grew by around 20% Y/Y

0.7 0.7 0.8 1.1 1.0 1.02.4

1.12.5

5.7

8.2

3.0 3.5

5.0 4.6

6.3 6.5

0.2 0.20.8 1.4 1.8

2.23.5

3.9

4.4

8.8

12.7

11.4

9.09.1

10.2

13.2

0.91.0

1.92.4

2.8

4.6 4.6

6.4

10.1

17.0

15.7

14.9

14.013.7

16.5

19.8

0

2

4

6

8

10

12

14

16

18

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

$b

n

Issued Outstanding from previous years


0.40

0.90

1.40

1.90

2.40

Ja

n-0

2

Jul-

02

Ja

n-0

3

Jul-

03

Ja

n-0

4

Jul-

04

Ja

n-0

5

Jul-

05

Ja

n-0

6

Jul-

06

Ja

n-0

7

Jul-

07

Ja

n-0

8

Jul-

08

Ja

n-0

9

Jul-

09

Ja

n-1

0

Jul-

10

Ja

n-1

1

Jul-

11

Jan

-12

Jul-

12

Ja

n-1

3

Jul-

13

Barclays Ba US High Yield S&P 500 Total Return Swiss Re Global Cat Bond Index Total Return

Cat bond market delivered a steady stream of uncorrelated returns

7

Cat high yield performance January 2002 – November 2013

Cat bond market proved resilient despite financial market turmoil and natural catastrophes

5 bonds have been triggered by catastrophes(1) of the roughly 230 bonds issued (440 classes) since 2002, causing a total loss of USD 650m compared to USD 7.5bn of spread payments over the observed period

2002-2013 (YTD)

Barclays US High

Yield

S&P500 Total

Return

Global Cat Bond Index

Annualized Return

8.43% 5.63% 8.56%

Annualized Weekly

Volatility 6.58% 18.23% 2.60%

Majority of cat bonds are structured for very large catastrophes which, fortuitously, did not occur

Source: Swiss Re Capital Markets;

(1) 4 additional bonds lost some principal as a result of the Lehman Brothers default


8

Catastrophe Bond Capacity Deployed

The ILS Market is heavily weighted towards U.S. Hurricane:

Two thirds of the outstanding notional is exposed to U.S. Hurricane Events

Sponsors would see significant pricing difference between U.S. Hurricane and non-peak perils, as investors have strong demand for non-peaks

Outstanding Cat Bonds by Peril

US Wind

US EQ

Non Peak

Peril Overview for Outstanding Bonds

65%

53%50%

44% 44%

38%

28%

15%19%

10% 8%5% 5% 3% 2% 2% 2% 1% 0%

0%

10%

20%

30%

40%

50%

60%

70%

Pe

rce

nt

Exp

ose

d t

o P

eri

l

Source: Swiss Re Capital Markets. As of December 3, 2013 with percentages calculated based on notional amount


0

200

400

600

800

1000

1200

0 50 100 150 200 250 300 350 400

US Wind Non-US Wind

9

Increased demand from investors pushed cat bond spreads to new lows

(1) Swiss Re Capital Markets pricing indications only; estimated primary issuance spread computed for an expected loss of 2% using regression analysis

Illustrative primary issuance spread (US Wind) 1

Spreads for U.S. wind exposed bonds are down by 40% y/y, while non-U.S. spreads decreased by approximately 35%

Non-U.S. wind risk continues to price at tighter levels as investors seek diversifying risk

2013 primary issuance spread

expected loss

spre

ad

sp

rea

d


3%

6%

9%

12%

15%

2007 2009 2011 2013

10

Spread tightening is slowing, indicating that the market may have found a new price baseline

1 Data source: SRCM. Seasonally adjusted secondary market spreads for a subset of bonds that have a rating between B-/B3 and BB+/Ba1, a stated expected loss between 1.25-2.5% and are exposed predominantly to U.S. peak perils

Historical Average Seasonally Adjusted Spreads 1

(Cat Bonds Secondary Market)

Cat Bonds secondary market spreads

High yields, along with benefits of diversification are the major factors attracting investors to cat risks

Some investors have hinted they would potentially consider slowing down their commitment to the asset class should spreads drop any further

Spreads for top layers have been fairly stable over recent months. However, short term variability for lower layers is expected

0%

3%

6%

9%

12%


57.7%25.3%

13.0%

3.1%0.7% 0.3%

Dedicated

Money Manager

Reinsurer

Hedge fund

Insurer

Pension Fund

Shift from short term oriented to long term oriented investors

Pension funds through dedicated cat bond funds, mutual funds, institutional money managers are increasingly investing in cat bonds

The relative share of short term oriented hedge funds has decreased

While the investor base has broadened, dedicated cat bond funds remain the dominant category

Investors are increasingly comfortable with indemnity bonds and complex structures

50% of bonds issued in 2013 have an indemnity trigger

Cat Bonds expanded from providing "top-of-the-tower" cover with a remote ~1% Expected Loss towards the "working layers". A recent transaction featured an EL above 10%

11

Typical investor breakdown by type 2013

Source: Swiss Re Capital Markets

Cat Bond Trigger Breakdown (2009-2013)


12

Alternative capital is (re-)gaining market shares

Alternative capital grew sharply since 2011 to USD 45 bn

Dedicated cat funds are crowded out into collateralized reinsurance

Collateralized reinsurance grows fastest, reaching the volume of cat bond market

Indemnity capacity becomes widely accepted. ILW market shrinks significantly

Some sidecars are scaled back as a result of market softening

Alternative capital market share accounts for approximately 11% globally and about 17% in the U.S., exceeding the 2007 level (post-Katrina)

Estimated size of global market

Estimated market share (excl. Retro capacity)

0

5

10

15

20

25

30

35

40

45

50

2005 2006 2007 2008 2009 2010 2011 2012 2013

[bn USD]

Sidecar ILW Collateralized RI ILS



13

Alternative capital is largely focused on peak risks

Alternative capital plays a significant role in the U.S. Nat Cat and retro market, characterized by low entry barriers and still relatively high margins

Alternative capital struggles to expand outside the U.S., due to:

– Ample traditional reinsurance capacity

– Reinsurers offer traditional reinsurance at very competitive rates, leveraging their capital multiple times

– Lack of market loss indices

– Less reliable risk modeling

– Cannot offer reinstatements 70%

25%

5% US cat

European cat

Other

Distribution by segment and peril

33%

67%

Backingreinsurers

Backinginsurers



14

Demand for Nat Cat capacity will continue to increase

Demand for Nat Cat will further increase, on average by approx. 50% in mature markets and 100% in High Growth Markets by 2020

– Growth in exposed economic values

– Growing middle class in High Growth Markets (HGM) leading to higher insurance penetration

– Governments moving Nat Cat risks into the private sector

Alternative capital is expected to grow in the U.S. at least at the same pace and may gain further market shares

Increase in largest industry loss scenarios (2012 vs. 2020)

EQ: Earthquake (500 yrs)

TC/WS: Tropical Cyclones/Winter Storms (100 yrs); TC includes storm surge

FL: River Flood (250 yrs)

Nat Cat Demand Dynamic

Source: Swiss Re


Low interest rates combined with financial market uncertainties will persist and will foster further capital inflows into the alternative capital market

– Capital inflows will keep the demand for cat bonds high and spreads tight

– Some sidecars are scaled back as the result of market softening

Alternative capital (including cat bonds) is likely to gain further market shares but will remain a complementary product in the global (re-)insurance market

– Growth of alternative capital markets products is largely confined to peak risks

– Reinsurance remains very efficient

The staying power of capital markets investors has yet to be tested in case of a rise in interest rates, decreasing Nat Cat returns or large catastrophe losses

Alternative capital increases competition and capacity, but large, diversified reinsurers will be less impacted

15

Conclusion


16

* An investment in Insurance Linked Securities involves potentially significant risks for an investor. In summary, these risks include (but are not limited to): •Investors may lose all or a portion of their investment in Insurance Linked Securities if a natural catastrophe or other event triggers a payment by the issuer of the Insurance Linked Securities under the underlying risk-transfer agreement that the Insurance Linked Securities relate to. •The maturity of Insurance Linked Securities may be extended without the prior consent of the investor. •The Insurance Linked Securities may be redeemed before their maturity date (including before any extension of such maturity date by the issuer). •If the Insurance Linked Securities are redeemed before maturity, the interest rate payable under the Insurance Linked Securities will be reduced. •Investors have limited recourse to assets of the issuer of the Insurance Linked Securities and no recourse to assets of the counterparties to the underlying risk-transfer agreements to which the Insurance Linked Securities relate. •If the issuer of the Insurance Linked Securities becomes insolvent, investors may lose some or all of their investment. •Investors may be required to consolidate the issuer for accounting purposes under certain circumstances. •An investment in the Insurance Linked Securities may have adverse tax consequences for investors. •Any claim you have against the issuer in the event of the issuer's insolvency will rank below any claim a counterparty to the underlying risk-transfer agreements, to which the Insurance Linked Securities relate, has against the issuer. •Enforcement of the security interest granted to a Trustee for the benefit of the investors may be limited. •The Insurance Linked Securities may not have a secondary market or the secondary market for the Insurance Linked Securities may have limited liquidity; the market price of the Insurance Linked Securities in the secondary market may be highly volatile. •The Rating Agenc(y)(ies) (if any) may change any rating assigned to the Insurance Linked Securities. Any credit rating given in respect of the Insurance Linked Securities may not reflect the potential impact of all risks related to the Insurance Linked Securities. A credit rating is not a recommendation to buy, sell or hold the Insurance Linked Securities and may be revised or withdrawn by the rating agency at any time. The risk factors relating to an investment in Insurance Linked Securities are set out in detail in the offering materials for the relevant Insurance Linked Securities. Before entering into any financial transaction, you should ensure that you fully understand the terms, have evaluated the risks and determined that the transaction is appropriate for you in all respects.

Risk Factors


17

Disclaimer Swiss Re Capital Markets Corporation is a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”), and is regulated by the FINRA.

This document is solely for your use (“you”). The concepts and structures it contains are confidential and proprietary information, as well as business assets of Swiss Re Capital Markets Corporation and our affiliates (“SRCM”, “us” or “we”). They are shared with you for the exclusive purpose of allowing you to evaluate your interest in such structures. In particular, this information may not be used to discuss similar structures with any person SRCM could reasonably consider a competitor in this field. Unless otherwise agreed in writing, SRCM and its affiliates act solely in the capacity of an arm's length contractual counterparty and not as an adviser or fiduciary. Accordingly, you should not regard transaction proposals or other written or oral communications from us as a recommendation or advice that a transaction is appropriate for you or meets your financial objectives.

Any financial transaction involves a variety of potentially significant risks and issues. Before entering into any financial transaction, you should ensure that you fully understand the terms, have evaluated the risks and determined that the transaction is appropriate for you in all respects. If you believe that you need assistance, you should consult appropriate advisers before entering into the transaction. SRCM does not provide accounting, tax or legal advice. In addition, we agree that, subject to applicable law, you may disclose any and all aspects of any potential transaction or structure described herein that are necessary to support any U.S. federal income tax benefits, without SRCM imposing limitation of any kind. This material does not constitute an offer to enter into any transaction. Such material is believed by us to be reliable, but we make no representation as to its accuracy or completeness. This brief statement does not purport to describe all of the risks associated with financial transactions and should not be construed as advice to you.

Certain aspects of this presentation may give rise to perceived or actual conflicts of interest (i) between you and us and/or (ii) among you, us and other third parties. Such conflicts may arise from other business activities customarily conducted by other areas of our firm with you or with other clients. Such activities may include, but are not limited to, sales and trading activities. For example, we may already have executed similar transactions or strategies for our own account or accounts of other clients and we may have made similar presentations to others. Execution of any transaction contemplated in this presentation may involve other affiliates of SRCM and may result in perceived or actual self-dealing intended to generate revenue for our firm.

This document is for information purposes only and does not constitute an invitation or inducement or an offer or commitment, a solicitation of an offer or commitment, or any advice or recommendation, to conclude any transaction. While information herein has been obtained from sources believed to be reliable, we do not represent it to be accurate or complete. The information contained herein includes illustrations, estimates and projections and involves significant elements of subjective judgment, assumptions and analysis. Any views or opinions (including illustrations, estimates, statements or forecasts) constitute our judgment as of the date indicated and are subject to change without notice. No representation is made as to the accuracy of such illustrations, estimates or projections or that all assumptions relating to them have been considered or stated or that such projections or returns will be realised. The returns or performance results may be lower than estimated herein. Note that past performance is not indicative of future results. The information contained herein does not purport to contain all of the information that may be required to evaluate such solutions and you are encouraged to conduct independent analysis of the data referred to herein. We do not undertake to update this document.

11 35am schmutz, markus

Economy & Finance