Residential Reinsurance 2015 Ltd. (Series 2015-2)

This new cat bond issuance sees USAA looking to secure at least $100 million of fully collateralised reinsurance from capital markets investors, with a single tranche of notes being offered through the insurers latest Cayman Islands domiciled special purpose vehicle (SPV), Residential Reinsurance 2015 Limited.

A single Class 3 tranche of Series 2015-2 notes will be sold to ILS investors in order to collateralise a reinsurance agreement between USAA and Residential Re 2015, which will provide the insurer and certain affiliates with a four-year term cover for losses from multiple U.S. perils, on a per-occurrence basis and using an indemnity trigger.

The perils covered are typical of recent Residential Re cat bonds, U.S. tropical cyclones, earthquakes (plus fire following), severe thunderstorm, winter storm, wildfire, volcanic eruption and meteorite impact. We understand the tropical cyclone cover includes flood coverage for rental policies. The covered area includes the District of Columbia and all 50 U.S. states.

The notes would be triggered by a per-occurrence indemnity loss of above $1.493 billion, the attachment point, covering a percentage of losses suffered up to the exhaustion point at $2.23 billion. The initial attachment probability is 4.75%, with an initial expected loss of 3.26%.

Both those factors can flex depending on variable reset terms that USAA may choose to take, meaning these notes can get riskier, or indeed less risky, with investors being compensated depending on the level of expected loss. We’re told the expected loss can be reset from as low as 2.76% to as high as 3.76%.

The Series 2015-2 Class 3 notes are to be marketed to ILS investors with initial coupon guidance of 7% to 7.75%. At the 3.26% initial expected loss that would be a multiple of 2.15 times the EL at the lower end of guidance, or 2.38 times the EL at the upper end of price guidance. Of course if you look at the warm sea surface temperature sensitivity case figures the multiples decline somewhat.

The nearest comparisons in USAA’s long cat bond issuance history are two Class 3 tranches of notes from 2012 and 2013. Both attach at similar levels and have similar expected loss measurements, but the Residential Reinsurance 2012 Ltd. (Series 2012-2) Class 3 notes paid investors a coupon of 12.75%, while the Residential Reinsurance 2013 Ltd. (Series 2013-1) Class 3 notes paid a coupon of 9.25%.

Once again that demonstrates the rate decline in catastrophe bond coupons over the last few years, however it’s also important to note that neither of those deals included volcanic eruption or meteorite impact risks, which while very small contributors to expected loss are there in the more recent deals all the same.

Rating agency Standard & Poor’s said that it has assigned a ‘B-(sf)’ preliminary rating to the Series
2015-II Class 3 notes to be issued by Residential Reinsurance 2015 Ltd.

Interestingly, S&P put some detail behind the way it assesses non-modelled, or less well-modelled risks in cat bonds such as this, explaining that the “effect from tropical cyclones in nonmodeled states, wildfire, volcanic eruption, and meteorite impact has a de minimus effect.”

From the S&P pre-sale report:

The AIR model for hurricane does not include the following states: Alaska, Arizona, California, Colorado, Idaho, Iowa, Kansas, Michigan, Minnesota, Montana, North Dakota, Nevada, Nebraska, New Mexico, Oregon, South Dakota, Utah, Washington, Wisconsin, and Wyoming. AIR does not have models to analyze the risks from wildfire other than in California, and it does not have models for volcanic eruption or meteorite impact.

When determining the nat-cat risk factor, we believe the effect from tropical cyclones in nonmodeled states, wildfire, volcanic eruption, and meteorite impact has a de minimus effect. The largest current estimate of ultimate loss in nonmodeled states from a hurricane since 2003 is $1.1 million. For wildfire, the losses experienced by the ceding insurer for any single event outside of California did not exceed $80 million. Because this is a per-occurrence trigger, we do not consider wildfire a major contributor to the nat-cat risk factor.

There are approximately 165 volcanoes in the 50 states and approximately 120 of them are in Alaska and Hawaii. The Property Claims Service loss amount for the 1980 Mt. St Helens eruption was $27 million.

We considered a report from the U.S. Geological Survey that indicates volcanic activity may trigger earthquakes, and the less-well-understood relationship between earthquakes and volcanoes. Typically, the resulting event is of a smaller magnitude.

We were given information in the East Lane Re VI transaction that the 1908 meteor impact in Siberia was a 1-in-1,000-year event. The Barrington Crater in Arizona was formed by a meteor impact approximately 50,000 years ago. In February 2013, a large asteroid exploded above the Russian city of Chelyabinsk. The object’s air burst injured approximately 1,500 people and damaged more than 7,200 buildings valued in excess of $30 million. According to our sources, this is the largest known object to have entered the Earth’s atmosphere since the 1908 Tunguska event.

In March 2015, we rated East Lane Re VI Ltd Series 2015-I notes, which covered losses from volcanic eruption and meteorite impact. Our total adjustment to the nat-cat risk factor was 2 basis points; we applied the same amount for this issuance.

S&P also explained on the risk modelling of prior historical events:

Based on AIR’s analysis, on a historical basis since 1900, there has been one event–the 1938 unnamed hurricane that made landfall in New York and Rhode Island–that would have triggered the notes. The modeled principal reduction is 44%. The next three historical events that generated the highest modeled losses were 1926’s Great Miami hurricane ($1.432 billion), 1954’s Hurricane Hazel ($1.407 billion), and 2005’s Hurricane Katrina ($1.101 billion). The 1926 and 1954 events were very close to the current attachment point.

Based on AIR’s analysis, there have been three earthquakes since 1700 that would have triggered the notes. These (and the related modeled principal reductions) are the 1906 San Francisco quake (96%), the 1812 New Madrid sequence (52%), and the 1886 Charleston quake (21%). The next quake that generated the greatest modeled ultimate loss was the 1700 Cascadian subduction zone event. The modeled ultimate loss is $1.062 billion.

The exposure in these notes is greatest from tropical cyclones, with Florida the greatest contributor, followed by severe thunderstorms and then earthquake.

Update 1:

According to sources, the price guidance range has been narrowed at the bottom end of guidance, to 7% to 7.25%, as the book builds and nears closing.

With the notes having an initial expected loss of 3.26% at the base case the notes now look likely to pay investors a multiple of 2.15 times the EL at the low end of the tightened guidance, or 2.22 times EL at the new upper end of the range.

The sensitivity case expected loss is 3.65%, which would give a multiple of 1.92 times the EL at the lower end or 1.97 times at the upper end of the new range.

Update 2:

The Residential Re 2015-2 catastrophe bond upsized by 25% to $125m in size before pricing.

Update 3:

The pricing was set at 7.25%, the upper end of the tightened range.

The $125 million of Residential Re 2015-2 cat bond notes have an initial expected loss (EL) of 3.26% at the base case or 3.65% on a sensitivity case basis. With pricing now set at 7.25%, that results in a multiple of 2.22 times the base EL, or 1.97 times the EL for the WSST sensitivity case.