The price guidance on U.S. primary insurer State Farm’s $300m Merna Re V Ltd. U.S. earthquake catastrophe bond has dropped to the low-end of the marketed range, Artemis understands, making it the lowest coupon for a U.S. quake cat bond ever.
With Merna Re V providing protection for a very similar layer of State Farm’s reinsurance program as its 2013 Merna Re IV cat bond, having an almost identical risk profile, attachment point and expected losses, it makes this a very good cat bond issuance to examine for a demonstration of the decline in cat bond rates and coupons.
Through Merna Re V Ltd., a Bermuda domiciled special purpose insurer established to issue State Farm’s fifth Merna branded catastrophe bond, the insurer is seeking a $300m source of fully-collateralized reinsurance protection from capital market investors for the peril of U.S. earthquake risk.
The protection provided to State Farm by Merna Re V will be for losses from U.S. earthquakes in the New Madrid fault region, on a per-occurrence basis using an indemnity trigger based on State Farm’s ultimate net losses from qualifying quake events. The term of the Merna Re V cat bond protection will be over three years, with maturity expected at the end of March 2017.
The Merna Re V catastrophe bond was launched with price guidance for its $300m of notes marketed at a range of 2% to 2.5%. Artemis understands that price guidance has now been lowered to the bottom of that range with the notes now offered with pricing of 2%.
That is a 20% decline in the coupon offered during the marketing of Merna Re V, from the top end of the original range or 11% from the mid-point, taking the pricing multiple down to approximately 4.88 times expected losses.
The Merna Re IV cat bond, which completed almost a year ago, priced at 2.5% (so 20% higher) for an almost identical level of risk. The multiple of coupon to expected loss for last years Merna Re IV was higher at 6.25 times, demonstrating the increased ability and appetite of cat bond investors to take on more risk for lower return due to their lower cost of capital.
The 2% investment yield offered by the Merna Re V Ltd. cat bond is the lowest Artemis has ever recorded for an earthquake exposed catastrophe bond, setting a new low pricing mark for this peril. However if you compare the coupon and expected losses with other quake cat bonds it has a much higher multiple, at 4.88 times expected loss, than cat bonds like Bosphorus 1 Re Ltd, Kibou Ltd and Tramline Re II Ltd which all have multiples of 3 times expected loss or lower.
As prices continue to drop year-on-year and on comparable issuances it demonstrates just how much pricing has declined through the last 12 to 18 months on catastrophe bonds and property catastrophe reinsurance. Investors ability to assume risk at lower investment yields is representative of the lower cost-of-capital associated with the capital markets but even these investors will find a floor below which they will not support further price declines.
Given that we were discussing 25% declines in pricing in June 2013 it is no surprise to see this Merna Re V cat bond price down 20% compared to the issuance a year earlier.
What the market needs now is a few new cat bonds with higher yields to help ILS investment managers maintain return targets and to make the asset class even more attractive to investors. Investors still typically seek a 6%+ return from investments in cat bonds, so issuances at 2% while still attractive to the investor base need to be complimented by transactions with higher premiums.
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