That seems unlikely that they paid out as expecting considering we had record levels of default. The mark to market value of the MBSs didn't collapse because of increasing interest rates. They collapsed because of heavily increasing defaults.
Risk cannot be destroyed, but it can be moved. Tranching lets one control this. So if 95% of a pool default, and 5% don't, and you prioritize their payments to a premium tranche, that premium tranche will continue performing. (The specifics are more complicated [1].)
[1] http://quantlabs.net/academy/download/free_quant_instituitio...
And when the borrowers defaulted on their mortgages, the property backing the mortgage went to the holders of the mortgages and got sold off to pay off the MBS holders.
Nevertheless, a 1% risk of default does not mean you might lose 1% of your money - it means 1% of the time you are going to lose 100% of your money, and 99% of the time you are going to lose 0%.