Compass Re II Ltd. (Series 2015-1)

Compass Re II Ltd. will seek to issue a single $200m tranche of Series 2015-1 Class 1 notes, with the goal of providing a source of reinsurance protection to AIG and its affiliate companies.

The cat bond will cover U.S. wind risks along the Gulf and East coasts, from Texas right through to Massachusetts, we’re told. Coverage is on a per-occurrence basis and using a parametric index trigger, which will be constructed using actual event parameters reported by the National Hurricane Center.

We understand that AIG is seeking just six months of reinsurance protection with this cat bond, to run from the official start of the Atlantic hurricane season on June 1st, to the end of the season on November 30th.

The parametric trigger uses pre-defined points around the U.S. Gulf and East coastline and takes into account the location, maximum sustained winds and size (in terms of radius), of any qualifying storm or hurricane.

The coverage is for tropical and extra-tropical storms, as well as hurricanes, depressions and post-tropical cyclones, we’re told. Covering all bases with a broad but seemingly well-defined event definition, ensuring that the deal would be in-force for a repeat of superstorm Sandy as well.

Protection will kick in at a parametric index value, calculated based on the event parameters, from an index level of 100 up to exhaustion at an index level of 150.

We don’t have any details on the probabilities of attachment and expected loss for this deal. We understand that multiple risk modelling companies have assessed the transaction and will provide information to investors who are their subscribers.

We’re also told that AIR Worldwide has modelled the cat bond for rating purposes, but as yet the Fitch Ratings report is not available. Once that becomes available we may have more details.

Another interesting point about this catastrophe bond is that it has been structured as a zero coupon bond, so investors will receive premium at the end of the transactions term instead of coupon payments. As a result, the sponsor AIG will put the premium into the collateral trust at the start of the deals term, alongside the investors collateral.

Also noteworthy about this interesting transaction is the fact that this is the first cat bond to be structured by Rewire Holdings LLC, a firm that launched in September 2014 aiming to increase efficiency in the syndication of catastrophe risk to reinsurance and capital markets.

The Compass Re II 2015-1 cat bond is the first to be marketed using Rewire Holdings recently launched web-based marketplace, Rewireconnect, where investors can buy, sell or trade in ILS and catastrophe risk assets.

Using the platform will add efficiency to the cat bond transaction process for sponsor AIG and alongside issuing it as a zero coupon bond, which can be considered more cost-effective to issue, should make this deal compelling for them from a cost perspective.

Update 1:

Further details on the parametric trigger and index for Compass Re II 2015-1 catastrophe bond came available from the ratings report.

Fitch explains that the trigger would respond to events on a per occurrence basis, with the underlying trigger factors based on a parametric index. Fitch notes that this means that there will be a basis risk, because the event payout may not be the same as the actual claim experience of AIG.

Fitch goes on to explain the mechanics of the parametric trigger and the construction of the index value which would determine whether the Compass Re II cat bond faced a loss or not.

The parametric index trigger is based on the following parameters; latitude and longitude of the storm at landfall, radius of the storm and the maximum sustained wind speed. By bringing these factors together with weighting based on the location of landfall, a parametric index value can be determined.

Fitch explained:

The Windstorm Parameters of latitude and longitude at landfall and radius determine the Parameters X and Y used in calculating the Event Index Value. The Event Index Value is a mathematical formula that multiplies the Parameter X by the Maximum Sustained Wind Speed to the Parameter Y exponent.

If the wind speed and radius are not available at landfall, then the largest of the reading just before and after making landfall will be used.

If the Windstorm intersects multiple Boundaries, the respective Event Index Values will be summed to determine the Event Percentage (or the amount to be paid to the Ceding Insurer). There is a complicated linear interpolation formula, which is easily traceable in a spreadsheet format.

It’s certainly not the most straightforward of parametric triggers, as the event index value is determined largely by where a storm makes landfall. However, that allows AIG to calibrate the trigger to be most responsive in areas where a landfall is expected to cause a greater loss to the insurer, thus helping to reduce basis risk from the sponsors point of view.

Fitch continues:

Noteholders are exposed to principal loss if the Event Index Value exceeds 100.0 and face total principal loss if the Event Index Value reaches 150.0.

Assuming maximum sustained wind speeds of 100 mph and a 100 mile radius, the Notes would be triggered if a wind storm crosses certain parts of New Jersey coastline, but no other areas along the U.S. coastline.

Increasing the wind speed to 130 mph while maintaining the 100 mile radius, the Notes could be vulnerable if landfall occurred to certain parts of the Texas, Florida, Virginia and New York coastline. A category 4 hurricane is defined with wind speeds in excess of 130 mph.

So clearly the Compass Re II 2015-1 catastrophe bond is particularly sensitive to a New Jersey located hurricane or extra tropical storm landfall, likely as a result of the experience with Sandy.

Fitch explains that in terms of historical events, none that it looked at threatened the notes parametric index attachment point.

A repeat of Superstorm Sandy would result in an event index value of 25.275, Hurricane Rita would have been 21.642, while Hurricane Frances (a storm that made two landfalls) was just 3.034. Hurricane Camille in 1969 would have resulted in an Event Index Value of 61.135 using on an assumption that the radius of the storm was 90 miles.

Risk modelling firm AIR Worldwide provided a modelled analysis for the Compass Re II 2015-1 cat bond notes to assist with the rating process, the firm also acts as calculation agent.

AIR simulated 10,000 wind storm events to assess the notes, with its model producing an attachment probability of 2.41% which corresponds to an implied rating of ‘B+’ according to Fitch’s rating methodology.

A stress test using the Warm Sea Surface Temperature Conditioned Catalog had an attachment probability of 2.67%. The expected loss for the single tranche of Class A Compass Re II notes is 1.77%, 1.94% for the WSST catalog.

Update 2:

The Compass Re II 2015-1 cat bond upsized by 50% to reach $300m of notes offered at pricing.

The pricing, which began with guidance of 4.5% to 5.25%, finished at 5%.