Longevity Risk from the Perspective of
the ILS Markets
Morton N Lane Ph. D.
Director, M Sc in Financial Engineering,
University of Illinois
President,
Lane Financial LLC
Sixth International Longevity Risk and Capital Markets Solutions Conference
September 9,10th, 2010
Swiss-Grand resort and Spa, Bondi Beach, Sydney, Australia
1
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Size

The Natural Catastrophe Market is tiny compared to Life

Accumulated Issuance* in the past 15 years is $30 - $40 Billion

$12 Billion is currently outstanding

About 10% of the issuance has been in Extreme Mortality
* The universe under consideration is all bonds that contain a risk analysis, i.e. where there is an Expected Loss
2
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective; Exchange, Origins

The ILS market started with the Loss from Hurricane Andrew
in 1992. A market born out of disaster and commercial necessity

Its first incarnation was an Exchanged Traded Option (at CBoT)

The CBoT market died after 5 Years (Soft Market)

Since then, Exchanges have been tried in New York, Bermuda
London and again in Chicago. All would have enabled public
access.

None has (robustly) succeeded

The wrong Economics? Auctions?
3
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Indices

The following loss measures have been used on the Exchanges,

Loss ratios

PCS Industry Numbers (by region and proportionate to loss)

Guy Carpenter (customizable) loss ratios

PCS Industry Numbers (by region and binary event)

Hurricane Index formula (based on storm Intensity)
4
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Indices

Private transactions have used all the preceding loss indices
plus, Sigma, Munich Nat Cat Services, plus

PCS Industry Numbers (modeled to book), PERILS

Parametric earthquake measures, Wind speeds
Paradex, AIR, Modeled Loss, Computer modeled replications
of cedants book

To paraphrase Lance Armstrong, Its not about the Index
Its about the need – or opportunity If the need is there,
almost any index will do – Cat in the Box

Better Indices are good, but will not provide the tipping point.
20-30% of annual issuance remains indemnity based.
5
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective – Event Driven

The development of Cat bond has been event driven more
than anything else.

What are the extreme events that will drive Longevity risk?

Two that I believe stimulated the first mortality bonds were,
Terrorism (dirty bombs) and Pandemics

Swiss Re issued the first Mortality Bond the year after the
SARS outbreak and a little over 2 years after 9/11
6
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective – Event Driven

Nearly 90% of all Cat ILS are Occurrence based

Aggregate covers, even erodible thresholds are not popular

They are subject to greater secondary market fluctuation

What are the “Occurrence” event risks that need be transferred
by annuity/pension providers?

Cure for Cancer, Diabetes Pill, Shifts in Trend?
7
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective – Capital or Risk?

If the longevity risk has to be transferred because of mandate
or a desire to write or hold a bigger book

A sidecar, or quota share to a more appropriate analog than ILS

Sidecars have worked well to increase capacity in a hard
market. They do not serve to reduce risk in the retained book

Sidecars are not wanted when capital is plentiful
(even to generate fees)

Swaps which substitute fixed for floating seem like finite
reinsurance?
8
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective – Bonds or Swaps

Most ILS issuance has been done in the form of Bonds not Swaps
Bonds allow for distribution to many investors; Swaps tend to be
private 1:1 transactions or club transactions

Swaps depend on the rating of the counterparty, not the swap itself.
Also, if they need to be reversed, its usually the same counterparty

Bonds Ratings make for wider investor based distribution
Separately rated tranches also allow access to conservative and
more risk taking investors. Specialist and opportunistic investors

Rated Bonds also allows secondary market trading – necessary
for hedge fund valuations
Liquidity for all investors is in very high demand
9
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective – Bonds or Swaps

ILS structures have eschewed swaps since the Lehman Default

90% of all issues since the end of 2008 have avoided swaps (prior
to 2008, 90% contained swaps)

Where swaps are used they heavily collateralized and managed

ILS investors at present do not want counterparty credit risk
10
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Term

ILS investors and issuers like short terms –
the average maturity is between 2 and 3 years. Investors also dislike
long development period. This is a necessary component of
indemnity- based bonds, even PCS.

The longest ILS issued was 10 years. One three year bond took six
years to close – without an ultimate loss.
Dead Capital, frozen collateral.

Notwithstanding, the ILS market has been established,
participants behave rationally through the cycle

Maturities are extended in soft markets, shortened in hard ones
Terms and conditions tighten in hard markets , get more relaxed in
soft markets. e.g. more perils added
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LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Price

ILS investors require a high price to accept a risk, even a
diversifying one

Multiples of expected loss range from 2 to 20 times

Multiples will be higher in hard markets

Are cedant’s prepared to pay?
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LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Price
Multiple of Expected Loss on all ILS Issues
vs.
Expected Loss
14.0
12.0
Multiple
10.0
2004 to Q2, 2010
8.0
6.0
4.0
2.0
0.0
0.00
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.10
Expected Loss at Issue
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LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Price
2002
2003
2004
2005
2006
2007
2008
2009
2010
Total Issuance
Total
Issuance
Ext Mrt
$400,000
$400,000
$952,000
$852,424
$629,152
$100,000
$75,000
$50,000
$3,058,576
$362,000
$852,424
$629,152
$100,000
$75,000
$50,000
$2,468,576
Emb
Val
Issue
Sprd
Sprd
Multipl
EV EL Mrt
e
1.35%
$590,000
$590,000
1.45%
1.82%
0.30%
1.35%
6.50%
5.25%
1.50%
0.02%
0.71%
0.71%
0.06%
0.13%
0.03%
0.05%
0.46%
22.6
14.5
9.0
0.08%
18.7
14.1
14
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Price
4.0%
Monthly All CAT ILS and Life
Total Return Performance
2002 - Q2/2010
3.0%
All CAT Total Return Avg 0.668% Std Dev 0.759%
Life Total Return
Avg 0.370% Std Dev 0..470%
Percentage Returns (Monthly)
2.0%
Annual Equivalents
Avg 8.02% Std Dev 2.628%
Avg 4.439% Std Dev 1.628%
1.0%
0.0%
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
All CAT Total Return
-1.0%
LIFE Total Return
-2.0%
-3.0%
15
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Price
4.0%
Monthly All CAT ILS vs. Life
Finance Return Performance
3.0%
2004 - Q2/2010
All CAT Finance Return Avg 0.242% Std Dev 0.244%
Life Finance Return Avg 0.248% Std Dev 0.146%
Percentage Returns (Monthly)
2.0%
Annual Equivalents
Avg 2.903% Std Dev 0.846%
Avg 2.970% Std Dev 0.507%
1.0%
0.0%
Jan-04
-1.0%
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Floating Rate (LIBOR and/or Money Rate) (includes
Price Loss on 4 Bonds which had Lehman as TRS
Counterparty)
Life Financing
-2.0%
-3.0%
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LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Price
4.0%
Monthly All CAT ILS vs. Life
Insurance Return Performance
2004 - Q2/2010
3.0%
All CAT Insurance Return Avg 0.426% Std Dev 0.682%
Life Insurance Return
Avg 0.116% Std Dev 0.523%
Percentage Returns (Monthly)
2.0%
Annual Equivalents
Avg 5.117% Std Dev 2.630%
Avg 1.397% Std Dev 1.810%
1.0%
0.0%
Jan-04
-1.0%
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
All CAT Insurance Return
LIFE Insurance Return
-2.0%
-3.0%
17
LANE FINANCIAL
L.L.C.
Longevity Risk from an ILS Perspective - Price
4.0%
Monthly All CAT ILS vs. Life
Insurance Return Performance
2004 - Q2/2010
3.0%
All CAT Insurance Return Avg 0.426% Std Dev 0.682%
Life Insurance Return
Avg 0.116% Std Dev 0.523%
Percentage Returns (Monthly)
2.0%
Annual Equivalents
Avg 5.117% Std Dev 2.630%
Avg 1.397% Std Dev 1.810%
1.0%
0.0%
Jan-04
-1.0%
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
All CAT Insurance Return
LIFE Insurance Return
-2.0%
-3.0%
18
LANE FINANCIAL
L.L.C.
Mortality Bonds Trade with the Market

Absent Financing Rates Cat has Higher Returns

Most Cat bonds are Issued in the BB range

Most Extreme Mortality Bonds issued AA Range

Total Returns for CAT are therefore Double Life Returns

Deduct Financing - the “Insurance” Return is 4 times

Broadly the Bonds move in tandem –whether CAT or Life

Katrina affected Life and ILS – Hard Market

Lehman - both CAT and Life succumbed to Liquidity and CDS

Independent Life Behavior observed with H1N1 concerns
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LANE FINANCIAL
L.L.C.
END
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L.L.C.
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L.L.C.
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LANE FINANCIAL
L.L.C.