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Insurance-Linked Securities: First Quarter 2011 Update

An Interview with Mr. David Lalonde, Senior Vice President of AIR Worldwide

Aon Benfield Securities recently spoke with David Lalonde of AIR Worldwide. Mr. Lalonde provided insight into the role of independent modeling in the Insurance-Linked Securities market.

  • 1.

    What is your firm doing to stay current with the ILS market? AIR has been involved in the ILS market since its beginning in

    • 1996.

      Over the years we have been intimately involved with the industry in expanding perils and triggers available for securitization.

Issuers are constantly seeking ways to reduce their overall basis risk and, to support them, AIR is committed to developing innovative, standardized trigger mechanisms that provide a transparent view of risk. To that end, we are supporting the Verisk Catastrophe Index, a standardized structure that uses AIR’s models and PCS’s state-level loss estimates to provide a more granular view of insured losses resulting from US hurricanes and earthquakes and help both issuers and investors minimize their basis risk.

Investors, on the other hand, expect software to analyze their portfolios that is both sophisticated and easy to use. They need to model the risk associated with their entire portfolio of ILS investments —in combination with traditional reinsurance contracts —both of which can span multiple regions and encompass many dierent perils. To help meet investors’ needs, AIR has added software functionality and services to allow investors in this market to better assess their risk. This included enhancing CATRADER’s portfolio management functionality to enable investors to easily perform sensitivity analyses and evaluate the marginal impact of changing the makeup of their portfolios. AIR has also built a Data Cube to provide additional reporting capabilities specifically designed to meet the reporting needs of the ILS market. This functionality provides a straightforward way for investors to obtain aggregate views of their risk by region, peril or trigger type.

2. Are there extensions to the current models, or other updates that are being considered today?

Over the course of the last two years, AIR has significantly updated many of the key models used in the ILS market including the Earthquake and Hurricane Models for the US, the Earthquake and Typhoon Models for Japan and the European Wind Storm Model.

In addition, AIR has continued to expand the scope of its modeling eorts to provide risk estimates for even more territories. In an update scheduled for later this year, we are significantly expanding the coverage of some key models including extending our Atlantic Tropical Cyclone Models to additional Caribbean islands and providing model coverage for Central America for the first time. AIR is also extending its model coverage in Europe for both winter storms and earthquakes to make these models truly pan-European in scope. Providing comprehensive coverage provides

issuers with more options for ILS oerings and allows them to include previously non-modeled territories in their catastrophe bonds.

Finally, AIR continues to explore models for other types of exposure and has developed models to help quantify the risk from extreme mortality events resulting from both earthquakes and terrorism. We also continue to research the role of models in capturing longevity risk largely driven by interest from the ILS market.

3. How has your business model changed to maintain your contribution to the ILS market?

We have always invested substantial resources throughout the enterprise to keep our models up-to-date, particularly those used most frequently for securitizations. We have also seen our ILS team grow substantially to handle the increasing volume of transactions in the marketplace. Finally, AIR has recently established a dedicated Decision Analytics team that is focused on developing advanced analytics solutions to leverage risk model output and support our clients’ decision making processes.

More and more, we expect to leverage AIR’s integration with other areas of Verisk Analytics to better serve our customers. Verisk also has substantial exposure information and claims data for both natural catastrophes and extreme mortality events, which AIR can leverage to improve our models and allow more types of risk to be securitized.

4. Looking forward, what issues in the ILS market will need to be addressed?

Certainly, there is still a great deal of room in the market to standardize around an established set of trigger types. In today’s market, many bonds feature customized structures for each transaction, and while there is still an appetite for customization, standardization may be a catalyst that ignites the growth of the ILS market. For issuers, more standardization means lower issuance costs, as each and every document would not be customized for each deal. For investors, simplified and standardized materials means less time spent investigating every component of every deal.

AIR is committed to increasing transparency in the ILS market and has participated in the development of standardized structures for ILS transactions. Going forward, AIR plans to develop other standardized indices for regions outside of the US providing issuers with solutions that help minimize basis risk. This includes expanding the marketplace to bring in multi-strategy investors who may not have the time or expertise to dedicate resources to understanding all of the intricacies of this market.

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