Proprietary & Confidential
Personal Auto SecuritizationNorthwest Actuarial Forum
Parr Schoolman, FCAS, MAAAVice President & Actuary Aon Re Services
September 5, 2008
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Agenda Slide
Section 1 Securitization History
Section 2 Personal Auto Securitization
Section 3 Personal Auto Securitization Example - Axa Sparc2
Section 4 Conclusion
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Section 1: Securitization History
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Securitization HistoryUS Government Sponsored Entities
1938 US Congress established The Federal National Mortgage Association (“Fannie Mae”, or FNMA)
• Original mandate was to buy Federal Housing Administration and Veterans Administration loans from lenders.
1968 US Congress divides Fannie Mae into two organizations:
• FNMA – Privatized with a mandate to establish a secondary market of conventional mortgages
• Government National Mortgage Association (“Ginnie Mae” or GNMA) - remained a government entity within the Department of Housing and Urban Development, and used to finance government assisted housing programs
1970 The Federal Home Loan Mortgage Corporation (“Freddie Mac”, or FHLMC) was established as a government-chartered corporation owned by 12 Federal Home Loan banks.
• Eventually privatized in 1989
Though privatized, Fannie Mae and Freddie Mac can borrow directly from the US Treasury.
Source: The Handbook of Fixed Income Securities, Fabozzi, Frank J., 6thEdition, 2001
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Securitization HistoryMortgage Backed Securities
Asset securitization started with Mortgage Backed Securities associated with these GSE’s
• 1970 GNMA issued the first Mortgage Backed Securitization
• Freddie Mac followed in 1971, Fannie Mae in 1981
GSE’s pooled the mortgages they had purchased, and created securities with the resulting mortgage payment cashflows on these pools
• GSE’s guaranteed interest and principle payments on these securities
– GNMA securities had the explicit guarantee of the US government
– Securities issued by Fannie, Freddie where guaranteed by the GSE.
• Payments to bond holders on a monthly basis, including both interest and principle payments
Securities were pure pass-throughs, with principle and interest payments of the pooled mortgages shared proportionally by all notes
• Like quota share and pooling agreements for insurance
Source: The Handbook of Fixed Income Securities, Fabozzi, Frank J., 6th Edition, McGraw-Hill 2001
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30 YEAR MORTGAGE POOL PREDICTED PRINCIPLE SCHEDULE
1 25 49 73 97 121 145 169 193 217 241 265 289 313 337
Month
30 YEAR MORTGAGE PRINCIPLE PAYMENT SCHEDULE
1 25 49 73 97 121 145 169 193 217 241 265 289 313 337
Month
Securitization HistoryCMO Innovation
1983 Freddie Mac and Salomon Brothers created the first multi-class mortgage security – the Collateralized Mortgage Obligation.
Created Three Tranches – Short, Intermediate, and Long term obligations
• Short – Received first principle payments
• Intermediate – Received principle payments after Short notes were redeemed
• Long – Last to received principle payments
Source:
1. A Primer on Securitization, Kendall, Leon T., Fishman, Michael J. MIT Press, 2000
2. The Handbook of Fixed Income Securities, Fabozzi, Frank J., 6th Edition, McGraw-Hill 2001
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Securitization HistoryOther Asset Backed Security Innovations
• First ABS Transaction – 1985, Sperry Corporation sold notes backed by computer leases
• Auto Loans – First transaction in 1986, GMAC raised $4B in notes backed by automobile loans
• Other Asset Classes:
– Credit Card Receivables
– Student Loans
– Home Equity Loans
• Other innovations
– CDO: Securitization of pools of loans/notes/MBS/ABS
– CDO2: Securitization of pools of CDO’s
Source:
1. Cowan, Cameron, L – Testimony before the United States Howes of Representatives Subcommittee on Housing and Community Opportunity Subcomittee on Financial Institutions and Consumer Credit, November 5, 2003
2. Source: A Primer on Securitization, Kendall, Leon T., Fishman, Michael J. MIT Press, 2000
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Securitization Structuring
Structured Finance Securitizations are very similar to the concept of insurance
• Credit losses on pooled assets/receivables/cashflows are more predictable than when they are held separately – Law of Large Numbers
• Re-structuring cashflows of pooled assets allows for the creation of debt securities that have tranches with a lower probability of default than achievable if each asset evaluated separately
Tranche I
Tranche II
Tranche III
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Securitization – Basic Structure
Sponsor company exchanges asset pool for cash.
Collateral Manager purchases and manages assets in accordance with set guidelines.
Trustee ensures compliance with guidelines and structure features.
Special PurposeVehicle
(SPV)
Sponsor Company
Proceeds less Fees
Future CashflowsSenior Debt
Tranches
Preferred Shares
DebtInvestors
Priciple & Interestt
Residual Cashflow
Proceeds
Proceeds
Jr Debt Tranche Proceeds
Equity Investors, Sponsor Co
Asset Pool
TrusteeCollateral Manager
Debt
Proceeds
Proceeds
Debt
Proceeds
Shares
Priciple & Interestt
Fees
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Securitization Benefits
Borrower Sponsor/Originator Investor
More consistent funding availability
Ability to convert assets into cash Increased supply of “investment grade” debt
Increased borrowing options regarding duration and debt covenants
Profits on sale, with increased servicing income
More investment options regarding duration and credit quality
Cheaper source of capital for non-financial institutions compared to general debt issuance
More efficient use of capital Enhanced diversification and liquidity
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Section 2: Personal Auto Securitization
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Senior Debt Tranches
Personal Auto SecuritizationProposed Structure
A Special Purpose Reinsurer is created to issue debt, and provide reinsurance to sponsor insurance company.
Reinsurer issued debt is linked to the loss experience of the reinsurance agreement
• Debt will default if losses exceed threshold
• Otherwise, premium will be used to pay off debt and interest
Allows debt as part of the required capital to support the personal auto premium, reducing the ultimate cost of capital
Special Purpose
ReinsuranceVehicle
Sponsor Company
ReinsuranceAgreement
Debt Investors
Debt
Senior
Junior
Cash
Jr Debt Tranche
Debt
Cash
Sliding Scale Ceding Commission, Loss
Payments
Ceded Premium
Debt Investors
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Personal Auto SecuritizationTranches
Debt acts as a collateralized aggregate stop loss reinsurance cover
• If Loss Ratio > Tranche Attachment Loss Ratio, principle becomes at risk
• If Loss Ratio < Tranche Attachment Loss Ratio, principle repaid to debt investor
The closer the debt attachment loss ratio to the expected loss ratio, the longer the time required to settle.
• Jr Tranche typically covers a single accident year
• Sr Tranche can be a multi-year cover
Equity TrancheEquity Tranche
Jr TrancheJr Tranche
Sr TrancheSr Tranche
Expected Loss Ratio
Spread above ELR
Debt Trigger Loss Ratio
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Section 3: Personal Auto Securitization Example - Axa Sparc2
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Axa: SPARC2 Transaction
Transaction completed June 2007
Axa’s second auto (Motor liability) securitization transaction
• Securitized French motor liability in 2006
• This transaction securitized a motor liability portfolio of country specific subsidaries
Nexgen Re
Senior Debt Tranches Institutional
Investors
Debt
Senior
Junior
Cash
Jr Debt Tranche Institutional
Investors
Debt
Cash
Axa
Guaranty by Axa of each insurer‘s obligations under
Reinsurance Agreements
4 Reinsurance Agreements
Axa Belgium
Axa Germany
Axa Italy
Axa Spain
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Axa: SPARC2 TransactionDebt Tranches
Loss Ratio:
Class D notes
BB/BB-
39.2M Eur
+3.5%
Class C notes
BBB-/BBB
100.1M Eur
+5.3%
Class B notes
A/A+
220.0M Eur
+9.9%
Class A notes
AAA/AAA
91.5M Eur
+20%
69.0% 72.5% 74.3% 78.9% 89.0% 93.2%
Equity Tranche
Retained by Axa
Class D – Junior Debt Tranche covering a single accident year
Class A, B, C – Senior Debt Tranches covering multiple accident years
Equity Tranche – Retained by Axa
Debt Tranches are the equivalent of an aggregate stop loss reinsurance cover, providing 20.7% loss ratio points of coverage excess a loss ratio of 72.5%.
Class C noasfasdfasf
Rating (S&P/Fitch)
Amount
Loss Ratio Spread
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Axa: SPARC2 TransactionQuota Share Agreements
4 country specific subsidiaries entered into QS reinsurance agreements with Nexgen Re
Each subsidiary required to retain 15% of cession
Reinsurance treaties will cover claims arising from motor insurance for a period of 1 year only
Insurers pay premium to Nexgen Re, recieve back a fixed commission and proportional losses of the pool
Individual claim severities capped (varies by country)
Minimum average premium per policy guarantee provided by insurers
For each year, the sum of each insurer’s planned loss ratio is used to determine the Global Loss Ratio
• 69.0% for 2007
Axa guarantees each insurer subsidiary’s obligations under the reinsurance agreements
Nexgen Re
Axa
Guaranty by Axa of each insurer‘s obligations under
Reinsurance Agreements
4 Reinsurance Agreements
Axa Belgium
Axa Germany
Axa Italy
Axa Spain
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Axa: SPARC2 TransactionSenior Debt Tranches
Senior Debt Tranches
Maturity date July 2013, with an expected maturity date of July 2011
Three Tranches, with separate debt ratings
Covers multiple accident years (although only 1 at a time)
• If ultimate loss ratio is determined to be less than the senior note trigger, the notes are to roll over to cover the next accident year
• At the end of each annual cover period, reinsurance treaty may be renewed subject to rating agency affirmation, and that no loss ratio trigger or termination event has occurred
If loss ratio exceeds the trigger an appraisal procedure is triggered
• Auditor review of premium and loss files (open and closed claims)
• Actuarial review
• Process could take up to 2 years
Nexgen Re
Senior Debt Tranches Institutional
Investors
Debt
Senior
Junior
Cash
Jr Debt Tranche Institutional
Investors
Debt
Cash
Loss Ratio:
Class D notes
BB/BB-
39.2M Eur
+3.5%
Class C notes
BBB-/BBB
100.1M Eur
+5.3%
Class B notes
A/A+
220.0M Eur
+9.9%
Class A notes
AAA/AAA
91.5M Eur
+20%
69.0% 72.5% 74.3% 78.9% 89.0% 93.2%
Equity Tranche
Retained by Axa
Class C noasfasdfasf
Rating (S&P/Fitch)
Amount
Loss Ratio Spread
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Axa: SPARC2 TransactionJunior Tranche
Junior Debt Tranche
Maturity date July 2010, with an expected maturity date of July 2008
Attaches 3.5% loss ratio points above Global Plan Loss Ratio of 69.0%
Covers a single accident year
• Implication is that a separate Junior Tranche would be created for each new accident year
If ultimate loss ratio is determined to be less than 72.5%, the notes expected to be redeemed
If loss ratio is above 72.5% an appraisal procedure is triggered
• Auditor review of premium and loss files (open and closed claims)
• Actuarial review
Nexgen Re
Senior Debt Tranches Institutional
Investors
Debt
Senior
Junior
Cash
Jr Debt Tranche Institutional
Investors
Debt
Cash
Loss Ratio:
Class D notes
BB/BB-
39.2M Eur
+3.5%
Class C notes
BBB-/BBB
100.1M Eur
+5.3%
Class B notes
A/A+
220.0M Eur
+9.9%
Class A notes
AAA/AAA
91.5M Eur
+20%
69.0% 72.5% 74.3% 78.9% 89.0% 93.2%
Equity Tranche
Retained by Axa
Class C noasfasdfasf
Rating (S&P/Fitch)
Amount
Loss Ratio Spread
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Axa: SPARC2 Transaction Benefits
Axa Press Release June 4, 2007
This transaction also confirms that insurance-linked securities (ILS) are an effective alternative to the reinsurance market, even for diversified liabilities, while eliminating counterparty risk. In addition the growing ability to transfer risks to the financial markets should contribute to put the insurance industry on a level playing field with banks
“This new transaction further demonstrates AXA’s permanent search for innovation, which is a key driver of our Ambition 2012 program,” said Denis Duverne, AXA’s chief financial officer and member of the management board. “Through this pan-European securitization, AXA intends to crystallize the economic benefits of mutualisation and diversification and to anticipate the expected evolution of the regulatory environment (Solvency II), which will take into account the retained risks.”
“We are confident that the market for ILS will continue to develop, as they are an efficient risk and capital management tool for the insurance industry, as well as a new attractive asset class for investors.”
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Section 4: Conclusion
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Personal Auto Liability SecuritizationPotential Benefits, Challenges
Benefits
Alternative capital source for insurers
Allows for the creation of a more efficient capital structure for low volatility lines of business
Fully collateralized, eliminating counterparty risk associated with traditional reinsurance
Challenges
Regulatory and rating agency treatment
Accounting & Tax treatment
Sponsor Company Demand Strong capitalization reduces need for capital raising
Strong Debt Rating
Reversed cashflows compared to MBS, ABS transactions (securitizing cashflows around a liability, rather than an asset)