This year, Amtrak became the second major transportation company in the U.S. to tap the cat bond market.
The first, from New York City’s MTA, came out more than two years ago, in August 2013.
Amtrak’s $275-million deal showed that non-insurance companies see benefits to buying a chunk of their overall disaster protection from capital market investors instead of relying entirely on the insurance industry.
In a release, Amtrak’s Chief Financial Officer Gerald Sokol asserted that the three-year cat bond gave the railroad operator “a means to diversify our sources of insurance in a cost effective manner.”
There might have been another motivation as well.
A few months ago the railroad operator lost the bulk of a $1.2-billion lawsuit against a number of its insurance companies. Much of that case revolved around what was meant by the word “flood.”
Amtrak said how the insurance policies defined “flood” actually excludes inundation caused by a storm surge, which is what battered its facilities during Sandy.
This matters because the policies capped payouts for “flood damage” at $125 million. Amtrak could have gotten much more had it convinced the court that a storm surge is outside the bounds set by the flood payout limit.
The railroad’s cat bond, on the other hand, explicitly links pay out to storm surges of certain sizes, using what is known as a parametric trigger. Modeling found that a surge was what most correlated to losses for Amtrak. (History no doubt did as well).
This was the same peril used by the MTA in its cat bond two years ago.
Despite the kinds of advantages a cat bond might have for non-insurance companies, insurers or insurance pools remain the overwhelming majority of cat-bond sponsors.
In a Q&A in July, Ben Brookes of RMS, a catastrophe modeler, said that companies face a number of hurdles when determining whether cat bonds are right for them.
A prospective non-insurance cat bond issuer must determine which assets need coverage and how the coverage should work, he said. A company must determine which kind of trigger to use. Depending on where the sponsor feels it is most vulnerable as well as what kinds of risks investors might be up for, it might make sense to go parametric — a specific trigger for the cat bond to withhold payments to bondholders, such as a certain size earthquake — or indemnity — based on losses from the covered event.
What’s more, “you need…a way of modeling the risk so you can describe it to investors, and way of triggering the risk so you can objectively state that a claim is being made,” Brookes said.
There’s been an additional deterrent for companies to test the cat bond waters — insurance companies have been offering premiums that are competitive to the yields a bond sponsor would pay out. This was a new trend this year, as insurers and reinsurers fought back against the cat bond capital that had been increasingly encroaching on their terrain over the last several years.
As Brookes put it: “Alternative capital has begun to draw a line in the sand in terms of pricing...insurers and re-insurers are now competing to keep that business and winning it back in some cases.”
While we have yet to see more than a sporadic cat bond from non-insurer sponsors, there are companies looking into the possibility (or at the very least being pitched by bankers to do a deal).
In March, the CFO of Boston’s MBTA, Jonathan Davis, said the agency was re-considering cat bonds to protect against damage from snow storms. Record snow hit Boston last winter, with over 110 inches blanketing the city.