Fitch on Generali’s Lion I Re cat bond rating, highlights basis risk

by Artemis on April 23, 2014

Credit ratings agency Fitch Ratings is providing the rating for the single tranche of catastrophe bond notes being issued by Lion I Re Limited in the first cat bond transaction to be sponsored by one of the world’s largest insurers, Assicurazioni Generali S.p.A.

Lion I Re Ltd. is the first catastrophe bond to be rated by Fitch for some time, with S&P having rated the majority of the Rule 144A ILS or catastrophe bond transactions which sought a rating in recent years. Fitch issued a press release on the rating it expects to give the transactions notes once it is completed. The release provides some more insight into the Lion I Re cat bond structure and highlights that, despite this being an indemnity cat bond, an element of basis risk still exists.

The Lion I Re cat bond will provide sponsor Assicurazioni Generali with a fully-collateralized source of multi-year reinsurance protection against European windstorms. The cat bond transaction uses an on an indemnity trigger with coverage on a per-occurrence basis.

The Lion I Re cat bond launched with a €150m tranche of notes offered to investors, but that upsized and is expected to complete at between €180m to €190m in size, a possible increase of 27% in size. Perhaps giving a hint at the final size, Fitch’s press release refers to the Lion I Re cat bond as €180m in size.

At the same time as upsizing the pricing on Lion I Re dropped, as is to be expected with any cat bond in the market right now. It was initially marketed with a coupon price range of 2.5% to 3% but that range narrowed and was lowered to below the bottom of initial guidance, with the notes offered with a coupon of 2.25% to 2.5%.

Fitch notes that the Lion I Re cat bond covers a broad European region, the covered area is across Austria, Belgium, Czech Republic, Denmark, France, Germany, Ireland, Luxembourg, The Netherlands, Norway, Poland, Slovakia, Sweden, Switzerland and the UK.

Fitch highlights though that over 80% of the cat bonds exposure is located in three countries, Germany, France and Austria. Fitch also notes that the subject business covered by Lion I Re is primarily residential (70%) and commercial (21%) with a modest amount of industrial property covered.

Fitch provides some insight into the Lion I Re cat bond reset mechanism and terms, which includes a variable reset facility allowing Generali to adjust the expected loss within pre-defined boundaries.

Fitch explains; “Generali has the option to increase the subject business by 1.10 during any risk period. On each reset date, the attachment point and probability of exhaustion will be set to keep the modeled expected loss risk at 1.00%. Generali may exercise the option to adjust the expected loss in the second or third risk periods such that it falls in the range between 0.75% and 1.25%. If this occurs, the risk interest spread will be recalculated to reflect the marginal increase or decrease to the level of risk assumed by the noteholders. As the three risk periods are of unequal length, the risk interest spread will be multiplied by 0.72 and 1.54 in the first and third risk periods, corresponding to shorter and longer risk periods.”

Fitch highlights that while this is an indemnity cat bond there is some basis risk due to an element of the risk covered not being modelled, saying; “Risks that were not modeled by RMS included: the growth allowance of 1.10, storm surge (except for the west coast of U.K.), flood damage, hail damage, crop damage and currency exchange.

Fitch notes that it is the investors who will be exposed to this basis risk between the actual net losses that Generali experiences and the modelled loss information provided by risk modeller RMS.

This type of basis risk exists in almost every indemnity catastrophe bond, to some degree, where elements of the potential exposure are not included in the modelling. However it is often forgotten and indemnity catastrophe bonds are often discussed in terms of eliminating basis risk, which is not really true in most cases.

The Lion I Re cat bond essentially follows the fortunes of Generali’s underwriting and claims management processes over the next three years, as newly underwritten business may be included under the coverage. However Fitch notes that Generali maintains significant first-dollar loss protection, maintains reinsurance coverage beneath the layer where this cat bond attaches and also retains a portion of all losses above the attachment point.

Fitch expects to rate the notes issued by Lion I Re ‘B+sf’.

The Lion I Re Ltd. catastrophe bond completes this week. We will update you as the transaction progresses to market and you can find all the details on Lion I Re in the Artemis catastrophe bond Deal Directory.

Other articles on the Lion I Re Ltd. catastrophe bond from Assicurazioni Generali:

Assicurazioni Generali’s Lion I Re cat bond to upsize, price down.

Lion I Re Ltd. cat bond launches for first time sponsor Generali.

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