Mass Transit

SEP-OCT 2014

Mass Transit magazine features agency profiles, industry trends, management tips and new product information.

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SEPTEMBER/OCTOBER 2014 | MassTransitmag.com | Mass Transit | 79 arket Te majority of ceding companies uti- lizing the catastrophe bonds are primary insurance companies, which comprise more than 50 percent of the market, fol- lowed by reinsurance companies. Govern- ment-backed sponsors, such as residual markets and corporations comprise al- most 20 percent of the market today. Structure Te ceding company will enter into an insurance agreement or counterparty contract with an ofshore special purpose vehicle. Te sole purpose of the vehicle is to fulfll its obligations under this contract with the ceding company. Common domi- ciles for special purpose vehicles include Bermuda and the Cayman Islands, where there is no taxation at the entity level. Depending on the sponsor's require- ments, either derivative or insurance ac- counting treatment may be used for a ca- tastrophe bond transaction. Te governing document between the ceding company and the special purpose vehicle is a counterparty contract for a derivative, or swap, transac- tion, as compared to an insurance agree- ment for insurance accounting treatment. A ceding company may also consider utilizing a captive. Te original ceding company would cede premiums to the captive, which in turn would make the insurance premium payments to the spe- cial purpose vehicle. Recovery Mechanics Sponsoring companies have several structural options available for potential recovery. Over the years, signifcant shifs have been seen between indemnity and non-indemnity structures. Te indemnity structure most closely resembles the tra- ditional reinsurance market ultimate net loss cover and ofers sponsors the ability to recover based on actual losses. Other non-indemnity triggers have been used for a variety of reasons: quality of underlying data; commercial availabil- ity of catastrophe models or quality of the models; and, disclosure concerns. Model acceptance and basis risk are important aspects of ILS transactions that need to be properly assessed by both sponsors and in- vestors alike. Indemnity and industry index are the most common- ly utilized recovery mechanisms. In the last couple of years, sponsors have se- cured indemnity coverage with in- creasing success. Non-indemnity triggers, including industry loss, modeled loss and paramet- ric triggers, require analysis of the basis risk inherent in the structure. Te timing of insurance payments will vary depending on the recovery ba- sis. Recoveries from indemnity transac- tions will be based on actual paid losses and loss reserves. Te paid losses and commutation calculations for loss re- serves are also verifed by independent parties. Tis process typically takes a few years for large events. However, recover- ies based on parametric or modeled loss triggers typically only require a number of months for the payment to be received. ILS Investors Catastrophe bonds are not registered securities with the Securities and Ex- change Commission, and so may only be offered and sold to Qualified In- stitutional Buyers. QIB purchasers of catastrophe bonds are institutions that have met the suitability requirements of a 144A security. Under Rule 144A, an institution needs to manage at least $100 million in securities from issuers not affiliated with the institution to be considered a QIB. There are more than 100 experienced catastrophe bond investors, of which about 50 actively participate in new transactions. Investors may be catego- rized according to five broad types: ded- icated catastrophe funds; institutional funds that includes pensions, mutual funds, and hedge funds; and, reinsur- er-sponsored funds. Aon Benfield Securities Inc. Cat Bonds in 2013 Precent of property catastophe bonds had exposures to U.S. perils 73% Amount in the market $3 billion Note Proceeds Investors (Noteholders) Repayment Amount Permitted Investments Yield + Interest Spread or Extension Spread as applicable

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