Personal Auto Securitization Northwest Actuarial Forum

1. Personal Auto SecuritizationNorthwest Actuarial Forum Parr Schoolman, FCAS, MAAA Vice President & Actuary Aon Re Services September 5, 2008

2. Agenda Slide Section 1 Securitization History Section 2 Personal Auto Securitization Section 3 Personal Auto Securitization Example - Axa Sparc2 Section 4 Conclusion

3. Section 1: Securitization History

4. 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

5. 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

6. 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

7. 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: • 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 • Source: A Primer on Securitization, Kendall, Leon T., Fishman, Michael J. MIT Press, 2000

8. Tranche I Tranche II Tranche III 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

9. 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. Senior Debt Tranches Special PurposeVehicle (SPV) Sponsor Company Priciple & Interestt Future Cashflows Debt Proceeds Asset Pool Proceeds DebtInvestors Priciple & Interestt Jr Debt Tranche Debt Proceeds Proceeds Proceeds less Fees Shares Preferred Shares Residual Cashflow Equity Investors, Sponsor Co Proceeds Proceeds Fees Trustee Collateral Manager

10. Securitization Benefits

11. Section 2: Personal Auto Securitization

12. Personal Auto SecuritizationProposed Structure ReinsuranceAgreement Senior Debt Tranches • 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 Sponsor Company Special PurposeReinsuranceVehicle Debt Debt Investors Ceded Premium Cash Senior Junior Sliding Scale Ceding Commission, Loss Payments Jr Debt Tranche Debt Debt Investors Cash

13. Expected Loss Ratio Spread above ELR Debt Trigger Loss Ratio 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

14. Section 3: Personal Auto Securitization Example - Axa Sparc2

15. Axa: SPARC2 Transaction 4 Reinsurance Agreements • 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 Senior Debt Tranches Axa Belgium Nexgen Re Debt InstitutionalInvestors Axa Germany Cash Senior Junior Jr Debt Tranche Axa Italy Debt InstitutionalInvestors Cash Axa Spain Guaranty by Axa of each insurer‘s obligations under Reinsurance Agreements Axa

16. Axa: SPARC2 TransactionDebt Tranches Loss Ratio: 69.0% 72.5% 74.3% 78.9% 89.0% 93.2% Class C noasfasdfasf Rating (S&P/Fitch) Amount Loss Ratio Spread Equity Tranche Retained by Axa Class C notes BBB-/BBB 100.1M Eur +5.3% Class B notes A/A+ 220.0M Eur +9.9% Class D notes BB/BB- 39.2M Eur +3.5% Class A notes AAA/AAA 91.5M Eur +20% • 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%.

17. 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

18. 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

19. 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

20. 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.”

21. Section 4: Conclusion

22. Personal Auto Liability SecuritizationPotential Benefits, Challenges