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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