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Securitization is one of many tools available to a (re) insurer for risk or capital management purposes. The use of the capital markets to absorb insurance and related financial market risks, through securitization, increases the available capital to support these risks taken by (re) insurers and leads to greater capacity and a more efficient market.
Packaging life insurance risks into insurance-linked securities (ILS) enables sponsors to access additional capital in the fixed-income market, whose players value the ability to diversify risks and assets, and the opportunity to invest in instruments with a range of durations at attractive spreads.
Life ILS typically fall into three broad categories: first, catastrophe cover to manage peak risks, i.e., pandemic protection; second, embedded value (EV) securitizations to help firms manage their capital more efficiently; and, third, financing transactions, such as redundant reserve financing, i.e., "XXX" or "AXXX" securitizations where little or no insurance risk is transferred.
LIFE CATASTROPHE COVER
A good illustration of a life catastrophe cover is the Vita Capital program, which Swiss Re first launched in 2003 to cover its exposure should a lethal pandemic occur across a range of countries where the firm has its highest mortality exposure. The cover provided under the latest program, Vita Capital III, is based on increases in a mortality index during a period of two consecutive calendar years, in an overall risk exposure period of four years. The index is composed of age- and gender-weighted death rates from publicly available sources covering five countries: United States, United Kingdom, Germany, Japan, and Canada. The weights are designed to replicate Swiss Re's current geographic and demographic mortality exposure. The trigger points vary by class of security under the program, with the most junior risk classes issued to date attaching at 110% of the index and the most senior at 125% of the index.
The Vita Capital III structure-also illustrated by Exhibit 1-is as follows:
* Swiss Re enters into a derivative contract (the "Counterparty Contract") with Vita Capital III, which pays out to Swiss Re in the event the defined index increases above stated thresholds during the risk period.
* Vita Capital III issues floating rate notes (the "Notes") up to the notional amount of the Counterparty Contract to fully collateralize its...