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CATASTROPHE BONDS AND THE INSURANCE-LINKED
SECURITIES MARKET: A REINSURANCE COVERAGE
LAWYER’S VIEW OF THE SECURITIZATION MODEL
AIDA EUROPE CONFERENCE
REINSURANCE WORKING PARTY
26 MAY 2011
David M. Greenwald
[email protected]
The views expressed herein are not made on behalf of Jenner & Block LLP or any of its clients.
Jenner & Block LLP © 2011
CAVEAT
This presentation is not intended to be self-explanatory or to
present the subject material in significant detail. It is,
instead, a high level outline (often in shorthand form)
intended to serve solely as a starting point for fuller
explanation during live presentation.
David M. Greenwald
Jenner & Block LLP © 2011
2
THE ILS MARKET
• “Convergence” Of The Insurance Industry With Capital Markets
• Non-Correlated Investment For Capital Markets
• Additional Capital Available To Ceding Insurers
– Multi-year coverage
– Multi-peril coverage
– Collateralized
David M. Greenwald
Jenner & Block LLP © 2011
3
CATASTROPHE BONDS
• Designed To Transfer Catastrophe Risk From Insurers And
Reinsurers To Capital Market Investors.
• Types Of Catastrophe Bonds:
– Indemnity
– Modeled loss
– Indexed to industry loss
– Parametric
• Examples Of Perils Covered:
– U.S. hurricane and earthquake
– European wind
– Japan earthquake and typhoon
– Ceding insurer specific risk on book(s) of business
David M. Greenwald
Jenner & Block LLP © 2011
4
HISTORY OF INVESTMENT IN ILS MARKET
CAPACITY ISSUED AND OUTSTANDING BY YEAR
16
14.1
14
12.9
12.3
$ In Billions
12
11.8
Issued
Outstanding At Year End
10
8.5
8
7.2
6
5
4.8
4.6
SOURCE: Willis Capital
Markets & Advisory (ILS
Market Update Q1 2011)/
WCMA Transaction
Database
3.8
4
3.7
3.6
2.7
3.1
2.1
1.6
2
1.1
0.8
0
2002
2003
David M. Greenwald
2004
2005
2006
2007
2008
2009
Jenner & Block LLP © 2011
2010
5
TRADITIONAL REINSURANCE
Premium
Ceding Insurer
Reinsurer
Claims
Payments
•Long-Term Relationship
• On-Going Business
• (Re)insurance Professionals Handle Claims
• Transparency In Claims Submissions (Or At Least Right To Demand
Transparency)
• Potential Risks/Disadvantages To Cedant:
− Credit Risk of Reinsurer
− Lack of Multi-Year Cover
− Lack of Capacity/Unfavorable Pricing
David M. Greenwald
Jenner & Block LLP © 2011
6
Securitization Model
Sponsor
(Cedant)
ADMIN
LRVA
LRRA
CRVA
Premium
Claims Payment
Securities
SPE
(Reinsurer)
Premium &
Proceeds of
Issuance
Purchase
Price
P&I
CUSTODIAN/TRUSTEE
(Collateral Account)
P&I on
Collateral
Scheduled P&I
on Securities
Underwriter/
Initial
Purchaser
Purchase
Price
Securities
INVESTORS
(Often Multiple
Tranches)
SWAP
PARTY
David M. Greenwald
Jenner & Block LLP © 2011
7
Securitization Model
Sponsor
(Cedant)
ADMIN
Reinsurance Agreement
LRVA
LRRA
SPE
(Reinsurer)
Notes
CRVA
Indenture
COVERAGE ISSUES:
• Is there a covered loss?
• To subject business?
David M. Greenwald
CUSTODIAN/TRUSTEE
Security
(Collateral Account)
Interest
Jenner & Block LLP © 2011
INVESTORS
8
(DIS)ADVANTAGES TO INDEMNITY TRIGGER
• From Cedant’s Perspective:
– Minimizes “Basis” Risk
– Closest To Traditional Reinsurance
• From Investor’s Perspective:
– Decreased Transparency In Claims Process
– Delayed Payout: Potential Extensions of Maturity Date While
Claims Develop
• Both Parties Have Risk of Mismatch Between Maturity Date and
Development of Claims
David M. Greenwald
Jenner & Block LLP © 2011
9
TRANSPARENCY / CLAIMS ADJUSTING
• Traditional Reinsurer Has Ready Access To Claims Professionals
And Coverage Counsel
• SPE: “Atomization” of Reinsurer
– No Agent Clearly Designated To Evaluate “Covered” and “Subject”
– No Coverage Counsel Provided By Deal Structure (Issuer May Engage
Counsel, But Funding May Be Lacking)
• Coverage Issues Minimal If Defined By Objectively Verifiable
Trigger
– Parametric
– Index to Industry Experience
• Traditional Coverage Issues May Arise On Indemnity Coverage
David M. Greenwald
Jenner & Block LLP © 2011
10
OBSTACLES TO INVESTORS’
ABILITY TO PROTECT THEIR INTERESTS
Indenture Typically Presents Several Hurdles:
• “Limitation of Suits” Clause
• Noteholders must Notify Trustee of Default
• Noteholders must Notify Trustee of Continuing Default
• At least 25% of Outstanding Notes may request Trustee to initiate
Proceeding – Subject to satisfactory indemnification.
• Noteholders with at least 50% of Outstanding Notes may direct Trustee
to act.
• Take-Aways:
– May be difficult to organize 25% or 50% of Outstanding Notes
– Time-consuming to jump each hurdle
– May be onerous indemnification requirements
David M. Greenwald
Jenner & Block LLP © 2011
11
A PROPOSAL TO IMPROVE
INDEMNITY CAT BOND STRUCTURE
• Identify Coverage Counsel in Deal Documents
• Provide Funding Mechanism For Coverage Counsel
• Provide Mechanism for Noteholders and Claims and Loss Reserve
Agents to Request Issuer to Instruct Coverage Counsel to Review
Claim(s).
• Provide Clarification of Roles of Claims and Loss Reserve
Verification Agents regarding Claims Adjusting.
David M. Greenwald
Jenner & Block LLP © 2011
12
CATASTROPHE BONDS AND THE INSURANCE-LINKED
SECURITIES MARKET: A REINSURANCE COVERAGE
LAWYER’S VIEW OF THE SECURITIZATION MODEL
AIDA EUROPE CONFERENCE
REINSURANCE WORKING PARTY
26 MAY 2011
David M. Greenwald
[email protected]
The views expressed herein are not made on behalf of Jenner & Block LLP or any of its clients.
Jenner & Block LLP © 2011