The reinsurance industry got some surprisingly good news last month with a new CAT bond deal pricing. There was also the announcement of a new European product promising to increase transparency and boost capital market transactions in the near term.
French re-insurance company SCOR completed the first catastrophe risk insurance-linked securitization since the collapse of Lehman Brothers. The $200 million CAT bond, Atlas V, provides global reinsurer SCOR with multi-year property catastrophe coverage referencing hurricane and earthquake exposures in the U.S. and hurricane exposures in Puerto Rico. The deal is divided into three series of notes: $50 million Series 1 (rated 'B+' by Standard & Poor's), $100 million Series 2 (rated 'B+') and $50 million Series 3 (rated 'B'). The notes collectively offer blended coverage for subsequent events.
Deutsche Bank and BNP Paribas are joint bookrunners on the deal, with Guy Carpenter acting as structuring advisor. Deutsche will act as total return swap (TRS) counterparty on Atlas V. The Atlas V notes were placed with institutional investors around the world, ranging from dedicated insurance-linked securities (ILS) buyers to asset managers, banks, life insurers and pension funds. They were distributed globally, with 60% placed in the U.S. and the remainder in Europe.
"The market has been awaiting this first new CAT bond issue with revised structures for collateral management and disclosure," Jean-Luc Besson, chief risk officer for SCOR, said in a written statement. "We prove that stability together with innovation satisfies market demand even in today's extremely challenging financial markets. In the context of the current retrocession market for natural catastrophe risks, this CAT bond is a cost-effective and highly secure financial mechanism, providing additional protection for the [SCOR's] U.S. natural catastrophe risk exposures, further strengthening its capital shield."
The deal is designed to fix the problems that followed the Lehman default by setting new and substantially improved transparency and security standards for investors. It provides improvements in managing counterparty risk for SCOR and investors by employing a much-enhanced total return swap structure; full and permanent transparency regarding the asset development of the collateral for investors; U.S.-government-backed debt obligations as the underlying securities; and a top-up "margining" facility by the total return swap counterparty that guarantees that the collateral will constantly be replenished in any case of a drop in the underlying security.
Transparency is also improved through a payout trigger that is based on enhanced technology that minimizes the basis risk between SCOR's portfolio of U.S. treaty and facultative exposures and the Atlas V protection. The long-term aggregate zonal reinsurance (LAZR) technology is based on property claims services (PCS) losses that are disaggregated to county level by AIR Worldwide, a risk modeling firm.
This LAZR technology, which permits greater granularity and a more accurate assessment of correlation risk, will also be available to European insurers via the new European-based index called PERILS.
"When you compare Europe to the U.S, the U.S. uses PCS industry loss estimates as loss triggers for CAT bonds, which are an effective way of ceding natural catastrophe risk to the capital markets," said Richard Pennay, vice president at Swiss Re. To date, industry loss estimates have not existed in Europe. "Once PERILS fully establishes itself, we anticipate further CAT bond issuance in Europe."
PERILS, an independent Zurich-based company, has been established to aggregate and provide industry-wide European catastrophe insurance data as a subscription service. The aggregated data sets will be derived from data voluntarily provided by European-based insurers. "With different events you have a wide range of estimates that don't keep time track of real loss evolution," said Eric Paire, managing director and European solutions group leader at Guy Carpenter. "As regards to CAT bonds, the application has been more about a lot of European issuers going for parametric transactions. From an issuer point of view, this is not satisfactory because issuing on this basis raises a lot of financial questions regarding the basis risk."
With PERILS, two main issues are solved. First, it produces and disseminates a proper database of exposure so that investors and issuers can look at the same database of exposure; secondly, it produces an index of actual industry loss so that issuers and investors can look at it at the same time. "The feedback from insurers looking to do these types of deals in Europe has been that they are not comfortable working on a parametric basis," Paire said. "This product will allow for insurers to look beyond these structures."
But Paire said that the product did not in itself create the capital markets products - it only facilitated in the creation of these structures. "Once you have the index, it is up to the market participants to structure the products linked between that and using the PERILS database of exposure and loss reporting."
As the insurance industry feels the pressures of the broader economic turmoil, Paire said the current environment isn't optimal to test out new structures. Over the medium term, he anticipates appetite for products put together off of the risk modeled around the PERILS index. "This is a medium-term initiative, and in any case PERILS won't be completely ready to roll until January 2010," he said. "Over the next year we are compiling the information to make the platform optimal."
Presently, PERILS is in the process of acquiring a CEO and gathering industry data to support the new product. Once PERILS fully establishes itself, more CAT bond structures executed via the European markets are anticipated. "If you look at the relative performance of CAT bonds in the one to two years, it has outperformed other major asset classes," Pennay said. "The fundamentals are strong, and we are confident it will be a fairly busy year."
In terms of the industry loss warranty (ILW) side of business, Paire said there is still a set of people placing some funds on the capital markets with traditional reinsurance products. These players currently have a much greater opportunity to focus on the U.S. rather than European risks due to the existence of PCS for loss reporting. "The introduction of PERILS means that these investors and insurers will be able to take on European industry exposure through the PERILS index," Paire said.
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