A niche within an already esoteric asset class, bonds that transfer the risk of extreme mortality from insurers to the capital markets represent just 6%, or $1 billion, of the roughly $15-$16 billion of catastrophe bonds outstanding.
Participants expect that mortality bonds will always remain a fraction of the broader cat bond market, which primarily transfers the risk of property damage from earthquakes, hurricanes and floods. It is easier to predict mortality rates than it is to predict where storms will hit and how much damage they will inflict. Therefore life insurers are less incentivized to seek re-insurance in the capital markets.
But a recent $180-million deal providing coverage for SCOR Global Life shows that bond investors are now willing to accept a lower attachment point, which is the level at which the holders would start to see losses. Should demand remain at this level, the market will be more attractive to insurance companies than it traditionally has been, although it’s anyone’s guess whether they will take advantage.
“The attachment level has moved from very far out of the money to closer,” said Paul Schultz, CEO of Aon Benfield Securities. “If investor appetite continues at this attachment level, I think the market could grow.”
His firm was a lead arranger, along with BNP Paribas and Natixis.
Atlas IX, as the deal is known, was marketed as a two-tranche transaction. Standard & Poor’s gave a $75-million A tranche a preliminary rating of ‘BB+ (sf)’ and a $50-million B piece ‘BB (sf).’ The rating reflects the probability of attachment, expressed as a percentage of a mortality index composed of information from the U.S. Centers for Disease Control and Prevention. As a result, investors in the deal are exposed to mortality rates in the U.S.
From A to B, in Tranches
The attachment point for the A tranche was 104%, for the B tranche it was 102%. Ultimately, investor appetite was strong enough for the issuer to justify moving the structure from the A piece to the B piece only and therefore coming out with a deal with a lower overall attachment point, according to Nicolas Merigot, head of insurance solutions of Natixis Global Structured Credit & Solutions.
Once the mortality index exceeds 102%, the sponsor will start to recover principal, translating into losses for investors. Payments will be made to the sponsor until the index value reaches 104%, at which point the principal will be exhausted.
Generally the attachment point for mortality bonds has been above 104%. “No one had done the 102% level in the past,” Merigot said, adding however that making comparisons across mortality bonds is not a perfect science given that they use different indices and countries.
He said that, from both the regulatory capital and risk perspectives, the bond was an “incredibly efficient” trade for SCOR. This, Merigot added, could encourage new issuers, assuming that the portfolio of those issuers is large enough and does not have geographical concentration issues.
Pricing on the SCOR deal was 3.25% over a medium-term note issued by the European Bank for Reconstruction and Development. That instrument is priced at 3-month Libor plus six basis points. Among the more than 20 investors in the book were traditional buyers of a variety of insurance-linked securities and others that focus more on the life insurance field.
Sliding Mortality Rates
Any number of events could ratchet up U.S. mortality rates, causing the transaction to hit the attachment point. S&P counted among the deal’s risks “a man-made catastrophe, such as nuclear, chemical or biological war [or] terrorist attack; a natural catastrophe; or a substantial pandemic with very limited vaccine or known treatment.”
While the probability of any of these events is very low, the agency noted that data points for modeling in this area are generally in short supply. Mortality rates in the U.S. have been improving, more or less, for the last 100 years, with some setbacks such as the 1918 influenza epidemic.
Risk Management Solutions conducted the risk analysis for the transaction. Based on the firm’s results with certain adjustments, S&P said the cumulative probability of attachment was 1.44% through the end 2014, rising to 5.79% at the end of 2018. The bond has an expected term of five years and four months.
In addition to being relatively small, the mortality bond market is concentrated among very few players. Swiss Re, through the Vita Capital program, accounts for the bulk of deals. Other insurance companies that have sponsored deals include Scottish Annuity & Life Insurance, AXA Cessions, and Munich Re.