10 Catastrophe Bonds Closed Before Hurricane Season Opening

By Sarah Hills | June 1, 2010

Reinsurers transferred $2.35 billion in catastrophe risk to capital markets before the U.S. hurricane season that began Tuesday, higher than the $1.4 billion last year, as the catastrophe bond sector starts to resume normal issuance after the global financial crisis.

The cat bond sector, in which insurers transfer risks associated with natural disasters to investors, is expected to end the year at $4 billion to $5 billion, according to market participants.

The market ended 2009 with nearly $3.4 billion of risk capital through 18 transactions, a 25 percent rise over 2008.

When U.S. investment bank Lehman Brothers filed for bankruptcy in September 2008, investors were left with direct exposure to market losses on the collateral assets, and four bonds were downgraded by ratings agency Standards & Poor’s.

“I hope this year serves as a wake-up call that cat bonds are back to their more usual forward-looking mode of growth,” said John Seo, managing principal of cat fund Fermat Capital Management.

“This has been driven by the continued interest by sponsors to diversify their sources of coverage as well as obtain supplemental, multi-year coverage for fast-growing exposures, and by a reasonably stable outlook for the cat bond yield environment.”

Ten deals closed before the official start of the Atlantic hurricane season on June 1 after the completion of insurer USAA’s multi-peril cat bond via Cayman Islands-based insurance vehicle Residential Re (Res Re) at $405 million last week.

The total of $2.35 billion surpassed expectations of about $2 billion by this stage of the year. Swiss Re told Reuters last month it expected issuance to exceed $2 billion in the first half of 2010.


Despite predictions the 2010 storm season may be the most intense since 2005 — when the industry’s costliest disaster, Hurricane Katrina, led to more than $40 billion in claims — the higher issuance is not a result of the hurricane forecasts, investors said.

“To structure and issue a cat bond takes a minimum of three to six months, so most of the transactions in the market were planned a very long time ago,” said one Europe-based investor.

“Predictions very often do not materialize or are of very little use, which is why the reinsurance industry tends to ignore them.”

Any short-term reactions to storm predictions will be executed through the traditional reinsurance market or the derivatives markets with Industry Loss Warranties, an alternative form of reinsurance contract.

The bond by Res Re covers USAA for U.S. hurricane and earthquake exposure as well as severe thunderstorms, winter storms and wildfires.

Classes 1 to 3 of the bond are calculated on a per-occurrence basis and have been rated BB, B-plus and B-minus by Standard and Poor’s. The fourth tranche, based on annual aggregate, was not submitted to S&P and not given a rating.

Res Re will issue $162.5 million of Class 1 notes at a coupon of 6.60 basis points (bps) over Treasury Money Market (TMM) yields.

The $72.5 million of Class 2 notes will be at TMM yields plus 890 bps. The $52.5 million of Class 3 notes and $117.5 million of Class 4 notes will both pay a coupon of TMM yields plus 1,300 bps.

The bond was structured by Goldman Sachs, which is also joint book runner with Aon Benfield Securities. Deutsche Bank co-managed the transaction, while AIR Worldwide will provide the risk modeling capabilities.

Six catastrophe bonds closed in May in the run-up to the start of the storm season, with a heavy emphasis on covering U.S. hurricane exposure.

Munich Re’s $305 million bond Johnston Re covers hurricane risk for the North Carolina Joint Underwriting Association.

First-time issuer Chartis closed its $425 million bond Lodestone Re, which covers U.S. hurricane and earthquake exposure. Munich Re’s second bond issued in May, EOS Wind, closed at $80 million and covers European windstorms and U.S. hurricanes.

Nationwide Mutual Insurance Co closed its $200 million bond, Caelus Re II, in May to cover U.S hurricanes and earthquakes. Allianz completed its third offering in its $150 million U.S. hurricane and earthquake catastrophe bond program last week.

Res Re, USAA’s 14th cat bond, closed on Friday.

(Editing by John O’Callaghan)

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