More detail on USAA’s Residential Reinsurance 2013-2 cat bond

Artemis has now gleaned some more detail on U.S. primary and military mutual insurer USAA’s twenty-first catastrophe bond transaction under the Residential Re name,  Residential Reinsurance 2013 Ltd. (Series 2013-2).

Residential Reinsurance 2013-2 launched to investors last week and sees USAA looking to secure another source of fully-collateralized, capital markets backed, multi-peril and multi-year reinsurance protection from insurance-linked securities investors. Artemis has received some more detail on the transaction through conversations with investors and rating agency Standard & Poor’s pre-sale report for the deal, which covers one of the two tranches on offer.

First, it is worth looking at the contribution that primary insurer USAA has made to the catastrophe bond market over the years. Its first transaction was issued way back in mid-1997, since which it has issued cat bonds every year, sometimes twice per-year. The twenty-one Residential Re series cat bonds listed in the Artemis Deal Directory now total $5.611 billion of risk capital issued. That is approximately 10% of all cat bond issuance included in the directory, which shows the massive contribution USAA has made as a sponsor to the market. It’s also worth noting that none of USAA’s previous cat bonds have ever been triggered and all have performed as expected.

So, to recap the Residential Re 2013-2 cat bond deal features two tranches, both multi-peril and the whole transaction has a preliminary size of $120m, a number Artemis expects to see grow before the deal closes. Of the two tranches only one looks destined to be rated, the $70m Class 4 notes, as the $50m Class 1 notes are not included in S&P’s analysis on the deal so likely to remain unrated.

The $50m Class 1 notes will cover U.S. tropical storms excluding Florida, U.S. earthquakes, severe thunderstorms, winter storms and wildfires in California. The $70m Class 4 notes cover U.S. tropical storms including Florida, U.S. earthquakes, severe thunderstorms, winter storms and wildfires in California. Both tranches will provide protection on a per-occurrence basis and the transaction will use indemnity triggers for each of them.

The Class 1 notes are higher risk, with a probability of attachment of 21.38%, an expected loss of 13.06% and are being marketed with coupon guidance of 21% to 22%. The Class 4 notes are much less risky, with an attachment probability of 2.26%, an expected loss of 1.61% and offering a coupon in the range of 5.75% to 6.5%.

The Residential Re 2013-2 cat bond covers personal-lines losses only, including from homeowners, condominiums, rental and dwelling insurance policies. The coverage will benefit USAA itself, as well as affiliates including; USAA Casualty Insurance Co., USAA Texas Lloyd’s Co., USAA General Indemnity Co., Garrison Property and Casualty Insurance Co.

USAA will itself retain at least a 10% share of the losses in the attachment layer of the Class 4 notes, according to S&P’s pre-sale report. It’s likely that the same share will be retained in the Class 1 layer as well, which is typical of cat bond deals.

The cat bond will provide USAA and affiliates with protection over a four-year term, but across five risk-periods. The reason for this is that the first risk period is slated to begin in December 2013 but the annual resets are to occur on June 1st, ready for the hurricane season, meaning that there are risk periods of roughly six months and three of a year.

The transaction covers:

• Losses from hurricanes in; Alabama, Arkansas, Connecticut, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Vermont, Virginia, West Virginia, and the District of Columbia.
• Losses from earthquakes in all 50 states and the District of Columbia. However, it will not cover losses arising out of property damage caused by fire following in Hawaii or Alaska.
• Losses from severe thunderstorms and winter storms in the 48 contiguous states and the District of Columbia.
• Losses from wildfire in California.

Based on risk analysis from AIR Worldwide, no historic hurricane or earthquake generated net losses that would have resulted in losses for note holders for the Class 4 notes. The next three historical events that generated the highest modeled losses for the Class 4 tranche were the 1906 San Francisco earthquake ($1.972 billion), the 1812 New Madrid earthquake ($1.828 billion), and the NoName4 Hurricane that made landfall in 1938 in New York ($1.625 billion).

Given the low attachment point of the unrated Class 1 tranche of notes Artemis understands that historical modelling showed that a number of events would have caused a loss to noteholders. For example, Artemis is told that the NoName4 Hurricane that made landfall in 1938 in New York would have caused a 100% loss of principal to the Class 1 notes, as would hurricane Hazel which struck South Carolina in 1954 and hurricane Katrina which struck New Orleans in 2005. A number of other historical hurricane events would have caused some loss of principal to these notes.

Three historical earthquake events would have caused a 100% loss of principal to the Class 1 notes, Artemis understands. The 1906 San Francisco earthquake, 1812 New Madrid quake and the 1886 Charleston earthquake. No other modelled historical earthquake events would have breached the trigger.

According to S&P, at the current $70m size the Class 4 notes would provide cover for 7.63% of losses between the attachment point of $2.076 billion and the exhaustion point of $2.993 billion. That percentage will change if the tranche of notes increases in size.

The $50m of Class 4 notes, which attach at $400m of losses to USAA will cover 12.5% of losses (at the current tranche size, up to the exhaustion point of $800m. Again that percentage could change depending on the investor appetite for the riskier tranche of notes.

Residential Reinsurance 2013 Ltd. is a Cayman Islands domiciled special purpose vehicle and is being administered by Kane (Cayman) Ltd.

The proceeds from the sale of the notes will be deposited in a trust account and invested in U.S. Treasury money market funds.

Standard & Poor’s assigned its ‘BB-(sf)’ preliminary rating to the Series 2013-II Class 4 notes to be issued by Residential Reinsurance 2013 Ltd. The Class 1 notes have not been rated.

Further updates will be published as details of the transactions route to market become available.

Read all about Residential Reinsurance 2013 Ltd. (Series 2013-2), as well as USAA’s twenty other cat bond deals, in the Artemis Deal Directory.