Tradewynd Re Ltd. (Series 2013-1)

Tradewynd Re Ltd. is a Bermuda domiciled SPI established to issue series of cat bond notes to benefit AIG’s various subsidiaries with catastrophe bond protection from the capital markets.

In this first issuance from Tradewynd Re, a single tranche of Series 2013-1 Class 1 notes is being offered with a preliminary size of $100m, we understand.

The cat bond notes will be used to collateralize a source of multi-year reinsurance protection for AIG companies. The deal allows for new subsidiaries or affiliates acquired by AIG during the term of the transaction to be included under the protection, as of the start of a new annual risk period, provided the ceded business is substantially similar to the subject business.

The protection will be for named storms (so tropical storms and hurricanes) and also for earthquake risks. The earthquake protection also includes ensuing damage caused by ground-shaking, including fire following, sprinkler leakage, liquefaction, tsunami and ensuing flood that result in claims or liability in the covered area.

The protection afforded is on a per-occurrence basis and the transaction uses an indemnity trigger based on AIG’s ultimate net losses. The transaction will cover AIG for a five-year risk period.

The covered area for named storms is: 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, as well as the Gulf of Mexico and the Caribbean (Bahamas, U.S. Virgin Islands, Bermuda, Puerto Rico, St. Maarten, St. Martin, Jamaica, Barbados, Cayman Islands, Dominican Republic, Trinidad and Tobago, Dominica, Grenada, Guadeloupe, Haiti, British Virgin Islands, Martinique, Montserrat, Netherlands Antilles, Aruba, St. Kitts and Nevis, Anguilla, St. Lucia, St. Vincent and the Grenadines, Turks and Caicos, Antigua and Barbuda and St. Barts.

The covered area for earthquakes is for all 50 states of the U.S., the District of Colombia and Canada.

The transaction features a broad trigger, according to S&P, meaning that events which occur outside of the covered area, but that cause losses within the covered area, can qualify under the terms of the cat bond. This is a useful addition given the explicit inclusion of risks such as tsunami, as it means AIG’s losses from a tsunami affecting the U.S. coastline from an earthquake that could be thousands of miles away would still be covered.

The Tradewynd Re cat bond covers a diverse and unusual book of AIG’s insurance business. Some of the lines of business covered are extremely unusual in the cat bond market or even completely new to cat bonds and have never been included in deals before. The subject business includes AIG policies which have exposure to losses caused by physical damage and time element coverages and contingent time element coverages, according to S&P.

Time element coverages are largely business interruption related, items such as expenses, interruption costs, interest costs etc. This really broadens the potential for loss under the terms of the deal from a major catastrophe event, and makes the transaction about much more than just physical damage caused by an event, as the majority of cat bonds have always tended to be.

Specific lines of business included are; commercial property, energy and engineering, aerospace, marine, the physical damage component of AIG’s programs division, and the property components of AIG’s personal lines operations. The personal lines book includes residential coverage across the U.S. and Caribbean as well as items such as high net worth residential, auto, yacht and fine art. The energy and engineering part of the commercial book includes items such as oil refining, chemical operations, power generation, utilities and power plants, mining above and below ground, construction coverage and offshore oil rig coverage for exploration and production of oil and natural gas.

That’s an extremely broad book of business when you consider that the average cat bond includes commercial and personal residential properties, perhaps auto lines of business and some industrial risks. Including so many different lines of business makes it impossible to use any trigger other than an indemnity one and it is likely only now that investors have become so comfortable with indemnity triggers in cat bonds that a transaction like this has now become possible.

Interestingly, S&P mentions some coverages which are not included in the AIR Worldwide risk modelling for the deal. It cites damage to airplanes, marine and inland marine cargo, onshore oil rigs, and clean-up costs from pollution caused by covered perils. That last item, clean-up costs from pollution, is particularly interesting as with oil, energy and chemical risks included in the deal it suggests an element of spill liability is covered here too.

The explicit inclusion of the Gulf of Mexico is another important factor in this deal given the subject business includes energy and engineering risks such as oil exploration and drilling and the subject business also includes cargo, hull and recreational marine risks. This may be the first catastrophe bond to provide coverage for risks in the Gulf of Mexico itself.

Commercial property lines of business contribute the largest percentage to the deals expected loss, at 61.3%, consumer lines are next at 29.4% of expected losses, followed by energy at 5.2% and specialty at 4.2%.

The transaction, at its current size of $125m, will cover 25% of AIG’s losses between an attachment point of $4.5 billion and an exhaustion point of $5 billion. AIG is required to retain 5% of the ultimate net losses. The initial probability of attachment is 1.60%, expected loss is 1.43% and probability of exhaustion is 1.30%.

The notes began marketing offering investors an interest spread guidance range of 7.25% to 8.25%.

This Tradewynd Re cat bond features a variable reset feature which would allow the sponsor to adjust the protection the notes provide it. The attachment level can be adjusted within specified bounds, allowing the cover to move up or down the reinsurance tower and the interest spread would then be adjusted to compensate investors for either the increased or reduced risk. At each annual reset, of which there are four, the attachment probability must be between 1.2% and 2.2% and the interest spread paid to investors will fluctuate up or down accordingly, depending on AIG’s coverage needs.

Based on AIR’s historical loss analysis, there have been two earthquakes which would have caused the Tradewynd Re cat bond to default. The 1906 San Francisco earthquake would result in $6.76 billion in losses and the 1812 New Madrid quake would result in $5.64 billion, both causing a full loss of investor principal. The analysis showed that there have been no named storms which would have caused a loss of principal, with the closest in terms of modelled ultimate net losses being $3.51 billion from the 1926 Great Miami Hurricane, $3.37 billion from the 1938 Great New England Hurricane, and $2.64 billion from Hurricane Andrew.

The proceeds from the sale of the notes issued by Tradewynd Re will be deposited in a collateral account and invested in highly rated U.S. Treasury money-market funds.

In a press release, AIG explained; “A diversified portfolio of risks is reinsured under the transaction. Commercial lines coverages include commercial property, energy and engineered risks, marine and aviation. Consumer lines coverages include high net worth residential, auto, yacht and fine art. To fund its potential obligations to AIG, Tradewynd Re Ltd. issued a five-year, $125 million single tranche catastrophe bond.”

AIG seems committed to the catastrophe bond market as a source of reinsurance protection, saying; “AIG is a leader in the insurance-linked securities market, sponsoring $2 billion of cat bonds in the last three years. With this transaction, AIG is pleased to further advance capital market participation in insurance risks.”

Update: The tranche of notes offered by Tradewynd Re has grown by 25% to $125m while marketing.

At the same time the pricing has moved to the upper end of the original range, to 8.25%, which suggests that investors have demanded a higher coupon for this slightly unusual cat bond as it does contain some less well modelled exposures. That’s a multiple of 5.78.