Seminar on Reinsurance Seminar on Reinsurance Secondary Uncertainty/Parameter Risk in Pricing

Old Risk Financing Continuum Finite-Risk Range Risk-freeUnlimited Risk Timing Risk Investment Risk Underwriting Risk

New Risk Financing Continuum Insurance Markets Capital Markets Intermediaries Insurance Brokers Investment Banks Commercial Banks Insurers Reinsurers Insurance Risk Structured As Insurance Banks Investors Structured As Securities Financial Risk

Business Risk Insurance Products Residual Value Insurance Project Finance Financial Guaranty Structured Finance Collateralized Debt Obligations

Residual Value Insurance Definition  RVI indemnifies an insured against a loss that might occur if the sales proceeds of an asset are less than insured RV at a specific point in time.  Asset types: autos, rolling stock, airplanes, property.  Forms: Surety bond, insurance, indemnity.

Airline Residual Value Reinsurance Company Aircraft Manufacturer Leasing Company Commercial Bank Airline Aircraft Cost RVI Protection Premium Debt Repayment Loan Lease Payments Term Lease

Airline Residual Value Primary Risks  Current Market Value  Depreciation of Asset  Future Inflation  Correlation of Inflation and Depreciation  Default of lessee  Remarketing risk  Scrap value

Airline Residual Value Secondary Uncertainties  Impact of economy  Condition/aspects of the specific asset  Legal risks, e.g., perfection of security  Lessee behavior during lease and at end of lease  Shocks to value, e.g., 9/11, Gulf War

Collateralized Debt Obligations Definition A structured finance product that securitizes a diversified pool of debt assets into multiple classes of notes from cash flows generated by such assets. Types of Cash Flow CDO’s –Structure –Issuer Motivation –Asset Class –Country or Region

Collateralized Debt Obligations Transaction Structure and Mechanics Periods: pre-closing, ramp-up, reinvestment, amortization. Parties: asset manager, custodian, hedge, insurer. Overcollateralization and Subordination External Credit Enhancement Priority of Payments (“Waterfall”) Tests, triggers, and coverage ratios

Collateralized Debt Obligations Ongoing Cash Flows SPV receives interest payments and principal repayments on asset portfolio. SPV makes payments based on waterfall to –Trustee, hedge, noteholders, insurer, asset manager, equity investors. Asset manager manages the SPV assets.

Collateralized Debt Obligations Primary Risks Defaults Recoveries Macroeconomic Environment Correlations Asset Rating Migration Waterfall

Collateralized Debt Obligations Secondary Uncertainty Deviation from the “average” Age of the ratings of the individual assets Current market view of default risk Shocks to values, e.g., Enron, 9/11 Correlation among assets Collapse of manager