Trust: short-term low default paper proceeds interest remaining funds reinsurance premium redemption Insurance Company SPV CAT Bond interest insured loss proceeds proceeds equal maximum insured loss redemption equals funds remaining after any insured loss

Benefits capital markets allow greater risk sharing (Securitized Risk Transfer) CAT bond is a new asset class that has low correlation with other financial assets

Terminology CAT loss reinsurance layers of coverage excess-of-loss contract limit: maximum covered loss coinsurance

Terminology Rate on Line (ROL) = premium / limit Price = (ROL / actuarial probability) – 1 = premium / (limit x probability) – 1 E[loss] ≈ limit x probability So Price = premium/ E[loss] – 1 Price > 0 if premium > E[loss] Price < 0 if premium < E[loss]

Calculation Assume (for simplicity) premium is paid at end of year Suppose limit is invested at LIBOR If no claim is made, end-of-year value equals: Limit x (1+LIBOR) + Premium Promised CR = LIBOR + ROL

Exhibit 5: Layer 2 ROL Calculation Coinsurance = 10% Layer from $450 to $600 M Premium = $16.9 M Limit = .9x(600-450) = $135 M ROL = Premium / Limit = 16.9 / 135 = 12.5%

Exhibit 5: Layer 2 Price Calculation ROL = 12.5% Pr(loss > 450) = 4.5 % (from Exhibit 4) Price = ROL / Probability ≈ 12.5 / 4.5 -1 = 1.8 E[loss] ≈ .045 x 135 = $ 6.1 M < $16.9 M (premium)