DEMYSTIFYING CATASTROPHE BONDS FOR DEBT MANAGERS Abi bigail Bac - - PowerPoint PPT Presentation

DEMYSTIFYING CATASTROPHE BONDS FOR DEBT MANAGERS

Abi bigail Bac Baca Financial Advisory and Banking Aki ki Jai Jain Capital Markets Department

May 2018

CAT BONDS

 Basics & Structure; Benefits & Limitations  Market Dynamics  Benefits of using World Bank as an Issuer & Execution Process  Value Proposition for Sovereigns  Role of World Bank as an Advisor & Intermediary for Member Countries

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Basics & Structure Benefits, & Limitations

2

Cat bonds enable sponsors to transfer catastrophe risk to capital market investors through a special purpose vehicle (SPV). Provides protection equivalent to an insurance policy. Proceeds from the sale of the bond are invested in liquid and safe collateral. Returns from the collateral, combined with the premium paid by the sponsor enable the bond to pay higher than market risk-adjusted returns to investors. If no disaster trigger events occur, the investors get the enhanced coupon and receive the principal back at maturity. If events occur, some or all of the principal is transferred to the sponsor, with no repayment obligation.

CAT AT BONDS NDS IN GE GENER ERAL AL

Country Or Multiple Counties

SPV AAA Collateral

100%

Investors Investors Investors

Premium Payout Coupon Principal Principal

3

CAT BONDS: COMPARISON OF TRIGGER TYPES

Trade-offs between transparency, response time, and basis risk

Source: Risk Management Solutions

4

CAT AT BOND D PR PRICING ING – COUPONS UPONS AN AND MU MULTIPLES LTIPLES

Premium ium / E Expecte cted Losses

• Coupons (or premiums) on cat bonds are priced at multiples over expected losses.
• The lower the multiple, the better the value for the insured.
• Using the graph, the expected loss of an event is 2.41 percent
• The Premium (and coupon of the bond) is 4.95 percent
• The insurance multiple is 2.05, or 4.95/2.41

5

CAT BONDS: BENEFITS & LIMITATIONS

Benefits:  Risk Coverage: Multi-year coverage (longer than typical reinsurance contracts), with ability to lock in premiums  Pricing & Liquidity: Syndication to large number of global investors allows for efficient price discovery; tradable instruments with observable, secondary market pricing  Investor Base: Appeals to a large and growing pool on investors seeking uncorrelated assets and diversification  Credit Risk: Fully funded transactions, with no risk of missed or late payments  Premium Levels: Comparable to conventional (re)insurance (except for very low or very high expected loss transactions) Limitations:  Complex structuring requirements to set up SPV, Collateral Accounts  More parties and agreements involved, Due diligence is required prior to issuance  No reinstatement of coverage

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Market Dynamics

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CAT BONDS: MARKET REVIEW

225 545 175 100 300 550 250 927.5 345 925 425 430 150 300 500 Q2 2018 Q3 2018 Q4 2018 Q1 2019 EU JP Other US EQ

Property Cat Bond Maturities by Quarter Property Cat Bond Issuance by Quarter Property Cat Bond Issuance and Outstanding by Year

Source: Aon Securities Inc.

Property Cat Bond Metrics

2018

Completed Issuances Sponsors Issuance Volume Average Deal Size 13 16 $4.91B $377M

2017

Completed Issuances Sponsors Issuance Volume Average Deal Size 33 29 $10.2B $307.9M

Total: $2,998M $1,075M $430M $,1645

Kilimanjaro 2018-1 & 2, Integrity 2018-1 and Residential 2018-1 have priced but not issued and are included in the figures above

27,159

2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 20,000 22,000 24,000 26,000 28,000 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 $ Millions Property Cat Issuance Property Cat Outstanding

300 1,015 1,343 520 1,210 1,494 2,015 1,970 3,380 2,300 592 2,095 3,303 4,492 2,652 800 6,378 1,529 232 674 529 1,441 250 650 925 460 2,018 1,990 1,888 1,877 2,075 1,425 1,850 1,353

2,000 4,000 6,000 8,000 10,000 12,000 2010 2011 2012 2013 2014 2015 2016 2017 2018 $ Millions Q1 Q2 Q3 Q4

As of April 30, 2018

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OUTSTANDING PROPERTY CAT BONDS BY SPONSOR

Reinsurers Insurers Other

Source: Aon Securities Inc.

Q1 2018 is a record quarter for ILS Issuance

• In total, over $3.3 billion of bonds were issued during Q1 of 2018, a new high-water mark for first

quarter issuance tallies, and far exceeds the 2016 and 2017 first quarter issuance volumes with each at approximately $2 billion

Kilimanjaro 2018-1 & 2, Integrity 2018-1 and Residential 2018-1 have priced but not issued and are included in the figures above

500 1,000 1,500 2,000 2,500 3,000 3,500 Everest XL SCOR Allianz Validus Munich Re Axis Aspen Amlin USAA Zenkyoren Allstate State Farm SJNK Nationwide Mutual Tokio Millenium Mitsui Sumitomo Heritage Travelers Safepoint American Integrity Chubb Security First Generali UnipolSai Tokio Marine ASIG GAIC Palomar Specialty ICAT AIG Covea American Coastal Avatar AmTrust Aioi Nissay Dowa FONDEN Chile Colombia Hannover Re… Amtrak Peru MTA CEA TWIA MA Property Citizens Property State… LA Citizens Turkish Cat Pool 2018 2017 2016 2015 2014 2013

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CAT AT BO BOND NDS: S: INV NVESTOR ESTOR DI DIST STRIBUTION RIBUTION

Investors by category Investors by geography

10

CAT AT BONDS: NDS: PR PRICING ING TRE TRENDS DS

Average ge Multi tiple les Prices are dropping given that more and more investors are accessing the market

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Benefits of using WB as an Issuer & Execution Process

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World Bank can function as an intermediary to transfer risk from a country or group of countries and the international financial markets.

• Highly adaptable to the particular needs of the client (type of risk, documentation, coverage terms,

legal and budgetary requirements, etc.).

• Responsive to market conditions and able to reach wide range of investors to get competitive pricing
• Can cover the risks of central governments, national companies and sub-national entities
• Offers enhanced counterparty credit risk protection
• Reduces legal, modeling, brokerage and issuance costs

Country Or Multiple Counties

Reinsurers Reinsurers Reinsurers Investors Investors

WBG

Derivatives Insurance/ Reinsurance Cat bonds

Investors

WB’S RISK TRANSFER INTERMEDIATION PL PLATF TFORM ORM

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BENEFITS OF IBRD CAPITAL-AT-RISK PROGRAM

 Eliminates the time and expense of setting up and managing a SPV  Alleviates potential concerns of using a SPV structure which are typically set up in

• ffshore jurisdictions

 Eliminates the cost of setting up a collateral trust (IBRD is triple-A rated, alleviating the need to hold segregated collateral)  Streamlines the process and cost of appointing agents for modelling, escrow, etc.  Makes the Cat bond issuance process more stream-lined and cost-efficient because of the IBRD’s existing tax and securities law exemptions in the US, the EU and elsewhere.  The proceeds of the issue are used for developmental purpose, making the bonds a socially responsible investment (SRI) for the investors  World Bank is a leading provider of natural disaster risk insurance and is an established issuer in the Cat bond market with a high level of name recognition among ILS investors (over $2 billion of Cat bonds issued to date)

14

CAT BONDS: EXECUTION PROCESS WITH WORLD BANK

 Engage underwriters and transaction counsel  Engage modeling firm, design trigger structure and prepare modeling documentation  Prepare prospectus, marketing materials, calculation agency agreement and post event loss calculation procedures  Marketing, investor calls, and “roadshow” (if required)  Book-building Process  Bond is priced  Risk coverage starts (roughly 3-6 months from start date)

15

Value Proposition for Sovereigns

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CAT T BO BONDS: NDS: VAL ALUE E PRO PROPOSITI POSITION ON FOR R SO SOVER EREI EIGNS GNS

➢ Global economic losses from disasters now over $300 billion per year, and disasters create implicit contingent liabilities. ➢ Cat bonds provide a hedge against these liabilities by transferring risks to capital markets. ➢ Because they are issued through an SPV or intermediary, Cat bonds do not count as debt stock of the sponsoring sovereign. ➢ Factored by rating agencies in overall assessment of sovereign credit risk. ➢ Can be linked to objective/parametric triggers that generate quick payouts for disaster response.

Total Loss Insured Loss

Wind (hurricanes and tropical cyclones) Earthquakes Tsunamis Flood Drought Pandemic Examples of Perils / Risks to Manage

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CAT T BO BONDS: NDS: IDEA EAL L FOR R COVERIN ERING G LOW OW FRE REQUE UENCY NCY, , HIGH GH SE SEVER ERITY Y EV EVEN ENTS

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Role of the WB as an Advisor & Intermediary for Member Countries

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WB HELPS COUNT UNTRIES RIES ES ESTAB ABLISH LISH A D A DISAS ASTE TER R RI RISK SK FINANCING ANCING PRO PROGRAM GRAM

1.

• 1. Qu

Quantif ify ri risk exposure – what are the contingent liabilities related to disaster and climate hazards? 2.

• 2. Des

Desig ign a com

• mprehensiv

ive ri risk fi financing strategy – what instruments are currently available? Where are the gaps that can be covered with a combination of products to finance retention and transfer of risk? 3.

• 3. Eval

aluate op

• ptio

tions for

• r ri

risk tran ansfer – which instrument is most cost effective for the specific perils? What option and legal documentation aligns with country’s financing needs and regulatory environment? What is the target budget? 4.

• 4. Des

Desig ign and execute cap apital l market tran ansac action for

• r ri

risk tran ansfer– which trigger and coverage parameters best fit the needs?

20

The countries of the Pacific Alliance – Colombia, Chile, Mexico and Peru – worked together to implement an innovative solution that benefits all countries. Technical Support

• WB provide advisory services , supported by the Swiss Government,

in the year proceeding execution focused on bring Chile, Colombia and Peru quickly up to speed as they were considering risk transfer for the first time.

• Improve general understanding of Insurance Linked Securities (ILS)

market and instruments

• Explain risk transfer options relative to limitations/preference of each

country from legal, regulatory perspective

• Supervise catastrophe risk modeling to develop risk profiles and

example risk transfer structures

• Customize legal documentation for risk transfer

2014 M8.2 Iquique 2015 M 8.3 Illapel 2010 M8.8 Maule

1960 M9.6 Valdivia 1997 M6.9 Cariaco 1999 M6.2 Armenia

2007 M8.0 Pisco

Pacific Alliance Countries Joint Cat Bond

21

Fin Financial Sol Solution

• $1.36 billion (2nd largest cat bond ever issued)
• Provides coverage to Pacific Alliance members Chile,

Colombia, Mexico and Peru.

• 1st and largest simultaneous issuance for 4 countries.
• Simultaneous issuance has advantages:
• Diversification for investors; and
• Economies of scale and pricing advantages for

issuers

Pacific Alliance Countries Cat Bonds

Tran ansacti tion

• n Sum

ummary Nom Nominal l amount: USD1,360,000,000 (with USD2,500,000,000 in

• rders)

Clas lasses: Chile – USD 500 million Colombia – USD 400 million Mexico (a) – USD 160 million Mexico (b) – USD 100 million Peru – USD 200 million Tenor

• r:

3 years for Chile Colombia and Peru, 2 years for Mexico Ris isk k Premiu ium: Chile – 2.5 percent Colombia – 3.00 percent Mexico (a) – 2.50 percent Mexico (b) – 8.25 percent Peru – 6.00 percent

22

Transaction Structure IBRD

1 Bond with 5 classes I. Chile II. Colombia III. Mexico A IV. Mexico B V. Peru

Republic of Chile FONDEN MEXICO

Hacienda/MoF

Republic of Colombia Republic of Peru

Risk Premium Risk Premium Risk Premium Risk Premium

BONDHOLDERS

• f
• Chile Class
• Colombia Class
• Mexico Class A
• Mexico Class B
• Peru Class

Cumulative Risk Premium WB funding margin

Principal of the Bond Could be eroded by a POTENTIAL LOSS PAYMENT POTENTIAL LOSS PAYMENT

Pacific Alliance Countries Joint Cat Bond

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0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 0% 1% 2% 3% 4% 5% 6% 7% 8%

• Chile
• Peru
• Colombia
• Mexico B
• .

Mexico A EXPECTED LOSSES RISK PREMIUM

Expected Loss Risk Premium Multiples Chile 0.86 2.5 2.91 Colombia 1.56 3.00 1.92 Mexico Class A 0.79 2.50 3.16 Mexico Class B 6.54 8.25 1.26 Peru 5.00 6.00 1.20

More frequent and less severe earthquakes Rare but very damaging earthquakes

Pacific Alliance Countries Joint Cat Bond

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Summary Points

• A cat bond can be a critical component of a risk financing

strategy

• Key value proposition is to strengthen fiscal resilience

which can improve discussions with creditors and rating agencies

• Not “one size fits all” – expertise is needed to match the

country’s need with the instrument

• Getting the best deal – Growing appetite from investors is

lowering premium costs, and multi country issuance can increase diversification benefits and share costs

Pacific Alliance Countries Joint Cat Bond

25

Annex: nnex: Ca Case se Studies Studies

IBRD RD Iss ssues s fir first-ever pan pandemic bo bonds cove covering all all 77 77 IDA DA co countries; s; earl early act activation mec echanism he helps s con contai ain pan pandemics s and and ex exponential al cos costs as assoc

• ciated wit

ith ou

• utbreaks.
• Following the Ebola crisis in 2014, the G7, World Bank and WHO committed to develop a more robust global pandemic risk management
• framework. The Pandemic Emergency Financing Facility (PEF), a parametric based insurance program, is designed to disburse funding

swiftly -- to governments, multilateral-agencies and non-governmental organizations in eligible IDA countries -- to support coordinated containment efforts to stop outbreaks of many of the most dangerous diseases.

• In June 2017, the first was executed transaction for PEF. This was the first time World Bank bonds and swaps were used to finance efforts

against infectious diseases, and the first time pandemic risk in low-income countries was transferred to the financial markets.

• Risk was offered to the market in public bond and derivative form. This dual format issuance was an innovation to appeal to the broadest

possible pool of risk takers. More than 30 separate investors including asset managers, pension funds, insurance companies and specialist catastrophe risk funds participated.

• The transaction raised $425 million through Class A Notes ($225 million bonds and $50 million derivatives covering Flu and Coronavirus)

and Class B Notes ($95 million bonds and $55 million swaps covering Filovirus, Coronavirus, Lassa Fever, Rift Valley Fever and Crimean Congo Hemorrhagic Fever.

Pandemic Emergency Financing Facility

27

De Development Cha hallenge

• Phil

Philippines s is is am among the he mos

• st vulnerable to

natural disasters.

• US$3.

US$3.5 bill illion in in asse asset lo loss sses s assess assessed an annually from typhoons and earthquakes. Fin Financial Sol Solution

• World Bank worked with the local government on a new

catastrophe risk insurance program to help the country better respond to losses from climate and disaster risks

• Philippine peso equivalent of US$2

S$206 6 mil illion in in cat swap ap coverage in in an an emerging g mar market lo local al curr rrency provided ag agai ainst losse losses fr from maj ajor r typhoons s and and eart earthquakes.

• 25

25 provinces s participate in program.

• 1s

1st: reinsurance agreement with a government ag agency cat risk transaction in loc local cu currency.

• PHP 83

83.5 .5m (US$eq. 1.6m) pa payout triggered by Typhoon Vin Vinta in December 2017.

Local Governments in the Philippines Cat Swap

28

De Development Cha hallenge

• Insurance pools allow countries to obtain group insurance against

risks at lower rates than they would pay for individual coverage.

• Like the other products, these policies rapidly put financial

resources in the hands of public officials in the aftermath of climate disasters. Fin Financial Sol Solution

• In June 2014, the Bank issued its first catastrophe bond under its

newly established Capital-at-Risk Notes Program to help the Cari aribbean Catastrophe Risk Risk Insu surance Fac acility (C (CCRIF)transfer the natural disaster risk of 16 member countries to the capital markets

• CCRIF leveraged on the World Bank’s experience, with the World

Bank Treasury guiding the outreach and investor discussions.

• This financial solution allowed CCRIF to secure multi-year access

to insurance at a fixed price, thereby achieving greater stability for its risk transfer program.

29

Caribbean Catastrophe Risk Insurance Facility

Transaction Summary Nominal amount: USD 30,000,000 Issuer IBRD Risks Covered Caribbean tropical cyclone and earthquake Issue Date June 30, 2014 Maturity Date June 7, 2017 Trigger Type Parametric modeled loss (KAC model) Risk Margin 6.50% Listing Luxembourg

Dev Development Cha Chall llenge

• Sma

Small ll eco conomie ies s hi high ghly ly expose

• sed to
• na

natural l di disaster: Cook Islands, Marshall Islands, Tonga, Solomon Islands, Samoa, Vanuatu.

• Lack of expertis

ise and and/or scale le to

• hed

hedge the these ri risks.

• Pool
• olin

ing provides diversification and be better cos

• st of
• f

ins nsurance.

Fin Financia ial l Solu Solution

• Pacif

cific ic Ca Catastrop

• phe Risk

sk As Asse sess ssment and nd Fi Fina nanci cing Ini nitia iativ ive pools risk to provide rapid payouts linked to impact of an earthquake, tropical cyclone or tsunami.

• $2

$232 32.5 5 mil illion in swaps provided coverage at competitive rates from the international reinsurance market.

• US$1

S$1.3 mill illion pa payout to Tonga triggered by Tropical Cyclone Ian in Jan anuary 20 2014 14.

• US$

S$1.9 mill illion pa payout to Vanuatu triggered by Tropical Cyclone Pam in Mar arch 20 2015 15.

Pacific Islands

30

De Development Cha hallenge

• Uruguay’s energy matrix is dominated by hydropower.
• 2008 drought and record high oil prices cost government more

than $400M in increased energy production costs.

• In 2012, UTE (national energy company) had to borrow from

market and withdrew $150M from Uruguay’s Energy Stabilization Fund, ultimately increasing consumer utility rates. Fin Financial Sol Solution Contingent loan and weather derivative for energy sector

• Combined Financing of $650 million through:
• US$

S$ 20 200 0 mill illion contingent fin financing op

• ption that provides

funding when adverse weather shocks happen and there are insufficient resources to draw upon in the Energy Stabilization Fund (reserve fund created in 2010).

• US$

S$ 45 450 0 mil illion cu customized wea eather de derivative provides coverage against combined risk of drought and high oil prices.

Uruguay

31

Transaction Summary Type of Contract Hydropower energy index- linked weather derivative Maximum Payout USD 450,000,000 (cumulative) Term 18 months from Jan 1, 2014 to June 30, 2015 Weather Index Uruguay Potential Hydropower Energy Index (“UPHEI”) Strike Specified units of the UPHEI index Settlement Dates Semi-annual (for a total of 3 semesters)

Contact Us

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Debt Securities@worldbank.org IDAInvestorRelations@worldbank.org http://treasury.worldbank.org +1 202 477 2880 1225 Connecticut Avenue, NW Washington, DC 20433, USA