Proprietary & Confidential Personal Auto Securitization Northwest Actuarial Forum Parr Schoolman,...

Proprietary & Confidential

Personal Auto SecuritizationNorthwest Actuarial Forum

Parr Schoolman, FCAS, MAAAVice President & Actuary Aon Re Services

September 5, 2008

2Proprietary & Confidential

Agenda Slide

Section 1 Securitization History

Section 2 Personal Auto Securitization

Section 3 Personal Auto Securitization Example - Axa Sparc2

Section 4 Conclusion


Section 1: Securitization History


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


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


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


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


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


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


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


Section 2: Personal Auto Securitization


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


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


Section 3: Personal Auto Securitization Example - Axa Sparc2


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


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


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


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


Investors

Debt

Senior

Junior

Cash


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


Rating (S&P/Fitch)

Amount

Loss Ratio Spread


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


Investors

Debt

Senior

Junior

Cash


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


Rating (S&P/Fitch)

Amount

Loss Ratio Spread


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.”


Section 4: Conclusion


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)

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