1. An Overview of Cat Bond:
Theory and Practice
1

2. Introduction
 The market for insurance risk transfer to the debt capital
markets started after Hurricane Andrew and the Northridge
Earthquake in the 1990s and has grown into an important
catastrophe risk management tool
 Cat bonds offer an alternative capacity source for natural
catastrophe insurance
 Investor interest continues to grow due to attractive yields and
increased understanding of natural catastrophe risk
 Since 1997,when the market began in earnest, by July 2009, 141
cat bonds have been issued, with total risk limits of USD27bn.
 Cat bonds and other ILS products may in the future prove to be
useful risk management tools here in China and elsewhere in Asia
2

3. Outline
• Cat Bond Basics
– Securitization Review
– Bond structure
– Case Study
• Market Dynamics
– From 1997 to 2004
– From 2005 to 2007
– From 2008 to present
• Prospect in China
– Urgency
– Challenges
– Suggestions
3

4. Cat Bond Basics:
1. Securitization Review
• Securitization:
– Packaging and selling of loans and other assets backed by
securities
– Result of securitization is ABS(Asset Backed Security)
– Investors bear return and risks
• Examples：
– XYZ Bank loans 10 people $100,000 a piece
– Put them in a pool and sell this pool to a larger entity, ABC.
– ABC will then split this pool into equal pieces.
– The pieces will then be sold to other smaller investors (as
bonds).
4

5. Cat Bond Basics:
1. Securitization Review
• Insurance-linked Securities：
– Transfer insurance-related risks to capital market
• category：
Non-life Life
Mass Risk Protection Financing tool by turning
Non-Cat
future income into capital
Motor Insurance Securitization Embedded value securitization
Regulatory capital
Our main
topic today Protection for extreme Extreme risk transfer
Cat
events
Hurricane and earthquake cat Mortality bond
bonds Longevity bond( first trial failed)
5

6. Cat Bond Basics:
2. Bond Structure
Other entities
• Cat Bond involved:
Risk Modeling
– Transfer catastrophe risk to capital market Firm;
Total Return Investment
Swap Bank;
is a financial Investments ③ Rating Agency
contract Bond Insurer;
which proceeds principle principle ②
.
transfers both ① premium
the credit risk Sponsor SPV Coupon
Investors
and market (Cedant) (Issuer)
Contingent
risk of an payment
principle
underlying Agreed
proceeds
asset. rate Loss
④ Reporting
Swap
counterparty Agency
6

7. Cat Bond Basics:
2. Bond Structure
• Trigger System：
Basis Risk is the – Transparency directly influence the issuer’s Basis Risk, higher
risk that, in the transparency leads to greater Basis Risk
event of a covered
loss, the payout • Sort：
determined by – indemnity-based
the bond
calculation will – index-based
differ from the • parametric trigger：ShakeMap (US) for earthquakes; AMeDAS ( Japan )
actual loss for typhoon
incurred by the • industry loss trigger：PCS( property claim services); Sigma; PERILS ( Pan-
sponsor. European Risk Insurance Linked Services); NatCatSERVICE
• modeled loss trigger）
– hybrid trigger
• Two-peril transaction, US hurricane and Japanese earthquake perils
7

8. Cat Bonds Basics:
2. Bond Structure
New Opportunity
• Sponsors Perception ( compared with reinsurance)
– Risk transferred are usually 100- 250 years
– Collateral guarantee for extreme event
– Lock risks with year-to-year constant price
• Investors Perception
– Less correlation with other assets return
– Good hedging instrument
8

9. Cat Bonds Basics:
3. Case Study: Blue Wings Ltd
Blue Wings is the
USD1bn multi-peril
• Sponsor: Allianz Global Corporate & Specialty AG
shelf program Blue Wings Ltd., a special purpose
sponsored by • Issuer: Cayman Islands exempted company
Allianz Global Swiss Reinsurance Company
Corporate & • Intermediary:
On or after the Initial Issuance Date, the
Specialty AG (AGCS),
and intermediated • Program design: Issuer may from time to time issue one or
by Swiss Re more Class(es) of Notes in distinct Series
pursuant to this USD1bn Program
Reinsurance Contract(s)
Allianz
Global Swiss
Definition of Corporate & Reinsurance
Specialty Company
Shelf Offering Premium
Financial Contract(s) Premium
Investment Income Proceeds
Blue Wings Ltd
SwapCounter-
Swap
Counterparty
party Coupon: LIBOR + spread Investors
Issuer collateral
LIBOR - spread & payment Return of Outstanding
+ Investment Losses Amount at Maturity
9 account

10. Cat Bonds Basics:
3. Case Study: Blue Wing Ltd
This innovative Class/Series: Class A, Series 1
transaction marks
an important step Principal Amount: USD 150 million
of the ILS market Covered Perils: A combination of Canada and US earthquake,
as it is the first cat excluding California (“EQ”), & Great Britain river
bond with risk flood (“FL”)
based on river
flood
Trigger: Modeled Loss for EQ & Parametric Index
for FL
Sole Arranger and Lead Manager: Swiss Re Capital Markets
Modeling Firm/Calculation Agent: Risk Management Solutions (“RMS”)
Flood Measurement Agent: Halcrow Group Limited (“Halcrow”)
Expected Loss: 0.54% (Annualized, 0.43% EQ; 0.11% FL)
Risk Period: April 4, 2007 to December 31, 2011
Maturity: January 10, 2012
Rating: BB+ (S&P)
Price: 3M LIBOR + 315 bps
10

11. Outline
• Cat Bonds Basics:
– Securitization Review
– Bond structure
– Case Study
• Market Dynamics
– From 1997 to 2004
– From 2005 to 2007
– From 2008 to present
• Prospect in China
– Urgency
– Challenges
– Suggestions
11

12. Market Dynamics
• Hannover Re issued the first cat bond in 1994
• In 1997, there existed five cat bond transactions which
marks the beginning of the Cat Bond Market
From 1997 to 2004 30
27
25
From 2005 to 2007
20 20
From 2008 to Pres. 18
15
13
10 10 10
9
8
7 7 7
6
5 5
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
12 Source: Guy Carpenter 发行数量

13. Market Dynamics
from 1997 to 2004(pre-Katrina period)
• From 1997 to 2004, CatBond Market developed slowly
with small amount of transaction and volume
12
10 10
9
8 8
7 7 7
6 6
5
4
2
0
1997 1998 1999 2000 2001 2002 2003 2004
发行数量
13 Source: Guy Carpenter

14. Market Dynamics
from 1997 to 2004(pre-Katrina period)
• Yearly new issued CatBond value
2000
1800
1729.8
1600
1400
1200 1219.5
1139 1142.8
1000 984.8 966.9
800 846.1
600 633
400
200
0
1997 1998 1999 2000 2001 2002 2003 2004
Source: Guy Carpenter 新发行债券额
• Reason
– Investors’ uncertainty about new instrument
– Complex design and high issuing cost
– Other substitutes such as catastrophe insurance
14

15. Market Dynamics:
Katrina Hurricane
• Date: 24-30 Aug, 2005
• Country/place: US, Gulf of Mexico, Bahamas, North
Atlantic, LA, MS, AL, FL, TN, New Orleans, Biloxi,
Mississippi, Mobile, Gulfport
• Event: with winds up to 224km/h, Mississippi banks
burst, New Orleans flooded, severe damage to oil rigs
• Casualty: 1326 dead;75,000 homeless; $45bn insured
loss; $135bn total damage
15 Source: Swiss Re sigma2006

16. Market Dynamics:
aftermath of Katrina Hurricane(1)
KAMP Re
protects Zurich
American • The first publicly disclosed total loss to a catastrophe
Insurance bond in KAMP Re 2005 .
Corporation
against U.S. • Rating agencies to revise their capital requirements
hurricanes for upward for insurers and reinsurers with catastrophe
three years and exposures
also against
quakes on the • Risk modeling firms to announce their intention to
New Madrid revise their models
fault. The bond
will be triggered • Because of these reasons, with the exception of one
if Zurich's losses offering, all 2005 transactions brought to market post-
from a single
storm or quake Katrina settled at yields considerably above comparable
rise above 2004 issues
$1bn.
16

17. Market Dynamics:
aftermath of Katrina Hurricane(1)
17 Source: Guy Carpenter

18. Market Dynamics:
aftermath of Katrina Hurricane(2)
• A dramatic rise in the cost of reinsurance for companies
that had suffered catastrophe losses
• A substantial increase in the degree of uncertainty
concerning renewal pricing and capacity available from
traditional reinsurance writers of catastrophe lines
• The placement of a significant quantity of cat bonds in
a short period of time to mitigate impending rating
agency concerns and secure fully collateralized capacity
18

19. Market Dynamics:
aftermath of Katrina Hurricane(2)
Source: Guy Carpenter
19

20. Market Dynamics:
from 2006 to 2007(post-Katrina Period)
• From 2006, CatBond began to develop rapidly
– Yearly new issued amount of bonds
30
25
20
15
10
5
0
2005 2006 2007
发行数量
– Yearly new issued value of bonds
8000
6996.3
6000
4693.4
4000
2000 1991.1
0
2005 2006 2007
20 新发行债权额

21. Market Dynamics:
from 2006 to 2007(post-Katrina Period)
• Shelf-offering become more and more popular
– This reflects that Cat Bond purchases shift from tactical to
strategic
Source:
Guy Carpenter
21

22. Market Dynamics:
from 2008 to present
• From 2008, influenced by Financial Crisis, CatBond
suffered slow development. Only 14 bonds were issued
in 2008, which is greatly below the level of 2007
30
25
20
15
10
5
0
2006 2007 2008
发行数量
22

23. Market Dynamics:
from 2008 to present
• The severe impact of the Lehman Brothers default on
Cat Bonds
– Lehman was the TRS counterparty to the collateral accounts
for four Cat Bonds
– The failure of Lehman left investments in these accounts
without protection
– The ratings of the four transactions were subsequently
lowered and prices declined
– By the end of July 2009, two of the four bonds had gone into
default
23

24. Market Dynamics:
from 2008 to present
• The market has now changed and future issuance will
be more transparent
– Enhanced transparency with regard to the investments held in
the collateral trust
– Tighter investment restriction for the collateral account
regarding quality, liquidity
– More frequent mark-to-market of the collateral with the TRS
counterparty required to post any shortfalls to the collateral
account
– Alternatives to traditional TRS structure such as posting the
collateral in a bank deposit
24

25. Outline
• Cat Bonds Basics:
– Securitization Review
– Bond structure
– Case Study
• Market Dynamics
– From 1997 to 2004
– From 2005 to 2007
– From 2008 to present
• Prospect in China
– Urgency
– Challenges
– Suggestions
25

26. Prospect in China:
1. Urgency
• (1)Frequent natural disaster
• (2)Limited underwriting capacity of property
insurance company and reinsurance company
26

27. Prospect in China:
1. Urgency
• Increase underwriting capacity of domestic
insurance industry
• Reduce government burden, establish long-term
catastrophe compensate system
• Develop capital market
27

28. Prospect in China:
2. Challenges
(1)Market challenges of issuing CatBond
• Demand side：lack of institutional investors
• Supply side: non-market operation of catastrophe risks
28

29. Prospect in China:
2. Challenges
• (2)Technical challenges of issuing CatBond
• Catastrophe indexes system巨灾指数体系
• Credit rating system信用评级体系
• Investment banking 投资银行等证券承销机构
• Risk modeling company风险模型公司
29

30. Prospect in China:
2. Challenges
• (3)Regulation challenges of issuing CatBond
• Missing relevant regulation
• Limitation of separate regulation between insurance
industry and security industry
30

31. Prospect in China:
3. Suggestions
• (1)Construct Catastrophe risk indexes system,
improve catastrophe pricing abiluty
—integrate catastrophe database
—country index, region index, province index
—establish simulate model of China catastrophe
• (2)Completed credit rating system
31

32. Prospect in China:
3. Suggestions
• (3) Develop Capital Market
—investment banking and evaluation intermediary
—Information revealing
Insurance company issuing CatBond should report
operation and financial status
32

33. Prospect in China:
3. Suggestions
• Government Leading Mode(Non-business)
– Practice in Taiwan
• Oversea Reinsurance Company Leading
Mode(Business)
33

34. Prospect in China:
3. Suggestions
34

35. Prospect in China:
3. Suggestions
35

36. References （参考文献）
• Guy Carpenter:
– Cat bond at the year-end 2002
– Cat bond at the year-end 2003
– Cat bond at the year-end 2004
– Cat bond at the year-end 2005
– Cat bond at the year-end 2006
– Cat bond at the year-end 2007
• Swiss Re:
– Sigma No.4/2009, the role of indices in transferring
insurance risk to capital market
– Sigma No.7/2006, Securitization: new opportunities for
insurers and investors
36

37. Questions & Answers
37

38. 38