1 / 24

Financial Risk Products: Case Study Perspective

Financial Risk Products: Case Study Perspective. Discussion Topics. Insurance Linked Securities Case Study I - Hypothetical ILS Transaction Case Study II - Basis Risk Transaction. 4. 2. 1. 3. Investment Earnings. Cash Proceeds. Reinsurance Premium. Principal & Interest.

lois
Download Presentation

Financial Risk Products: Case Study Perspective

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Financial Risk Products: Case Study Perspective

  2. DiscussionTopics • Insurance Linked Securities • Case Study I - Hypothetical ILS Transaction • Case Study II - Basis Risk Transaction

  3. 4 2 1 3 Investment Earnings Cash Proceeds Reinsurance Premium Principal & Interest Contingent Claim Payment Cash Proceeds Investment Earnings Scheduled Interest Securitization - Overview Investments Investors Re-insurer SPV Swiss Re Financial Products

  4. 1 2 3 Reinsurance Premium Contingent Claim Payment Fixed Amounts Fixed Amounts Floating Rate Amounts Floating Rate Amounts Swap - Overview Re-insurer Swap Transaction based on notional amount Investors Swiss Re Swiss Re Financial Products

  5. Case Study I - Overview Elements of a Capital Market solution • Understanding of situation • Risk mapping • Exposure • Structuring issues • Delivery mechanism

  6. Case Study I: Risk Source Earthquake (EQ) risks in California Source: United States Geological Survey, National Earthquake Information Center, www.neic.cr.usgs.gov

  7. Case Study I - Situation Analysis • ABC is global leader in the microchip industry • Its factory is based in Palo Alto, California • California is highly exposed to EQ risks • Therefore, ABC seeks for protection against a potential profit drop resulting from a devastating EQ harming its microchip production • Because of the current market conditions there is no cover available on the traditional insurance market; ABC approaches you to propose a Capital Market solution

  8. Intensity map epicenter Fault plane focus (hypocenter) Case Study I - Risk mapping, definition of EQ Magnitude (M) • Measurement of energy release • Richter Scale (and others) • M max: ~8.5 • Damage: M>=5.0 Intensity (MMI) • Observation of effects • Modified Mercalli Scale - MMI (and others) • MMI 12 degrees: I to XII • Damage: MMI >=VI MMI = Modified Mercalli Shaking Intensity, average soil conditions Source: Swiss Re Reinsurance & Risk, RN/CP, SNAP EQ

  9. Case Study I - Exposure In USD m Turnover Net profit Source: Annual Reports

  10. Case Study I - Risk mapping, return periods p.a.

  11. Case Study I - Structuring issues • Issuer’s Needs vs. Investor’s Demand • Loss Basis • Risk Profile • Triggering Event • Coverage Period • Other Structuring Considerations

  12. Case Study I - Delivery mechanism • Structured Note • Onshore vs. Offshore Issuer • Defeased vs. Non-defeased • Fixed vs. Floating Rate • Public vs. Private • Single vs. Multiple Traches • Derivative Instrument • Swap vs. Option • ISDA regs • Targeted Buyers

  13. Case Study II Basis Risk Swap Transactions

  14. Basis Risk Transaction • Exchange of cash flows based on two variable indices • Amount you pay and receive will change according to the movements in two separate indices • Basis Swaps • Common capital markets instrument • Capital Markets Indices • London Interbank Offer Rate (LIBOR) • Commercial Paper (CP) • F/X rates • S&P 500 • Etc.

  15. 6.80% 6.60% 6.40% 6.20% 6.00% 5.80% 5.60% 5.40% Year 1 Year 2 Year 3 Year 4 Year 5 Example: LIBOR versus CP • Domestic interest rates tend to move in the same direction • However, the difference between different interest rates will vary over time LIBOR CP

  16. Example: LIBOR versus CP • Company A issues commercial paper and invests in floating rate notes at L + 50bps • Company A does not wish to take the risk that CP rates will increase faster than LIBOR or decrease slower than LIBOR • Company A approaches Swiss Re Financial Products (SRFP) and enters into a basis swap • Company A pays LIBOR to SRFP • SRFP pays CP + 10 to Company A • Company A locks in 60 bps spread

  17. Floating Rate Notes LIBOR + 50 LIBOR Company A CP + 10 Commercial Paper Example: LIBOR versus CP Company A Receives from FRN: LIBOR + 50 Pays to SRFP: LIBOR Net: + 50 Receives from SRFP: CP + 10 Pays to investors: CP Net + 10 Total + 60 SRFP

  18. Basis Risk Transactions in Insurance • Potential Loss Tiggers in Re/Insurance Markets • Actual losses • Industry Losses • Loss ratios • Losses on different perils • Value of Basis Swap Transactions • To hedge a position already taken (reduce risk profile) • To arbitrage a market inefficiency (get cheaper overall pricing) • To be an innovator • To speculate

  19. Outside Source Indexed Protection Basis Transaction SRNM Corporate/ Insurer/ Reinsurer Basis Transaction #1 • Client gets indexed cover from outside source • Client enters into basis transaction with SRNM • Client pays to SRNM any recoveries made on indexed cover • SRNM pays client for actual losses incurred

  20. Indexed Reinsurance or Security or Swap or Option SRNM Corporate/ Insurer/ Reinsurer Indemnity Agreement Basis Risk Investors Basis Transaction #2 • Client gets indemnity cover from SRNM • SRNM issues indexed paper to the market • SRNM keeps the basis risk

  21. Portfolio Swap Indexed Reinsurance or Security or Swap or Option SRNM Corporate/ Insurer/ Reinsurer Basis Risk Outside Source Cal. quake Japan quake Basis Transaction #3 • Client receives return on a portion of SRNM’s California earthquake book of business • SRNM receives return on a portion of Client’s Japan earthquake book of business • SRNM may or may not enter into a transaction to hedge itself • Client’s overall book of business is better diversified

  22. Basis Swap Example • A XYZ Reinsurer is attempting to get windstorm coverage for Florida, Texas, and the East Coast • XYZ Re wants to pay 7% • No offers • XYZ Re approaches SRNM for alternative solutions • SRNM analyses XYZ Re’s book of business and determines the level of industry losses equivalent to the layer XYZ Re wants reinsured • XYZ Re purchases ILW for 6% from an insurer / CM investor(s) and enters into basis transaction with Swiss Re for 1%

  23. Basis Swap Example (cont.) • Basis risk transaction • XYZ Re pays claims to Swiss Re based on industry losses • Any claims XYZ Re must pay to Swiss Re it will receive from Insurer as part of ILW • Swiss Re pays claims to XYZ Re based on losses on XYZ Re’s reinsurance book • If Windstorm occurs and industry losses are large relative to XYZ Re’s book, Swiss Re receives payment • If XYZ Re’s losses are large relative to the industry, Swiss Re makes a payment

  24. 10 mm ILW XYZ Re Swiss Re Reinsurance 20 million - 50% QS Basis Swap Structure Basis Risk - Sell Reinsurance Buy ILW XYZ Re Receives from Ins. / Investor: Industry Losses Pays industry losses to SR: Industry Losses Receives payment from SR: Actual Losses Net: Actual Losses Insurer / Investor Texas to Maine ILW XYZ Re Swiss Re Basis Risk

More Related