East Lane Re VI Ltd. (Series 2015-1)

With this East Lane Re VI 2015-1 cat bond Chubb is seeking a new multi-year source of fully-collateralized reinsurance protection against multiple U.S. perils. The transaction will see a single Class A tranche of notes issued with a preliminary size of $225m, according to market sources.

As with all Chubb East Lane catastrophe bonds the ultimate beneficiaries of the protection provided will be a range of Chubb insurer subsidiaries, named as: Federal Insurance Co., Vigilant Insurance Co., Chubb Insurance Co. of New Jersey, Chubb National Insurance Co., Chubb Indemnity Insurance Co., Great Northern Insurance Co., Pacific Indemnity Co., Executive Risk Indemnity Inc., Executive Risk Specialty Insurance Co., Chubb Custom Insurance Co., Texas Pacific Indemnity Co., and Chubb Lloyds Insurance Co. of Texas.

The cover from this East Lane Re VI 2015-1 cat bond will be on an indemnity and per-occurrence basis.

The protection provided by the 2015-1 Chubb cat bond will be for the typical cat bond perils of U.S. named storms, earthquakes, severe thunderstorms, winter storms and wildfires as well as the first time included meteorite impact and volcanic eruption risks.

S&P notes that the East Lane Re VI 2015-1 cat bond issue will cover losses in the covered area due to named storms, earthquakes (including fire following and sprinkler leakage, losses related to which are included in the modeling), severe thunderstorms, winter storms, wildfire, volcanic eruption and meteorite impact on a per-occurrence basis.

RMS is the third-party risk modelling firm assigned to the transaction, however the firm does not have a risk model for northeastern U.S. wildfire, meteorite impacts or volcanic eruptions, S&P explains.

S&P says that when assigning the preliminary rating, the impact from wildfire, volcanic eruption, and meteorite impact had a minimal effect. S&P explained that the total adjustment to the probability of attachment due to these unmodelled perils is 2 basis points. S&P said that it does not anticipate any of these perils to result in losses that would reach the cat bond’s attachment point, however there is some minimal risk.

On each of the unmodelled perils S&P explains its thinking in the deal pre-sale report:

• For wildfire, prolonged periods without precipitation in the covered area are not typical. In addition, given the locations of the exposures, there is significant access to fire-fighting resources. Furthermore, the insured losses from the largest Western wildfires would not reach the attachment point.
• In terms of volcanic eruptions, there are no active calderas that RMS believes pose a threat to the covered area. (There are two volcanoes in New Hampshire, but these are considered inactive.) We also took into account a report from the U.S. Geological Survey indicating that volcanic activity can trigger earthquakes under some circumstances and that earthquakes can trigger volcanic activity as well, though the latter relationship is less well understood; typically, the resulting event is of a smaller magnitude.
• Regarding meteorite impacts, our sources consider the 1908 impact in Tunguska, Siberia, to be a 1-in-1000-year event. 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.

S&P highlights the unmodelled nature of these perils as one of the items of concern that it always notes about every cat bond deal it rates in the pre-sale report. However the rating agency explains; “The exposures that were not modeled are primarily exposures under commercial property and package forms that fall under a bundle of additional coverages, subject to a sub-limit, typically $500,000. Exposures in excess of $500,000 were included in the modeling.”

The risk period for the transaction will be five years, to March 2020, showing that Chubb is seeking to take advantage of broader coverage now available from cat bonds, and investors willingness to allow insurers to lock in longer-term reinsurance coverage.

The covered area for the deal is Chubb’s insurance heartland states of Connecticut, Delaware, the District of Columbia, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont and Virginia.

We understand that the initial attachment probability for the notes is set at 1.35%, with exhaustion at 1.14% and the expected loss at 1.24%. We’re told that this equates to a $2.1 billion indemnity trigger attachment point and a $2.45 billion exhaustion. That $350m gap between attachment and exhaustion points could hint at the ultimate size of the transaction, should Chubb elect to upsize it.

Property Claim Services (PCS) is being used for catastrophe designation on a number of the covered perils we understand, thus ensuring that only events of a certain magnitude and with a third-party agent designating them as catastrophes would qualify.

Other concerns S&P notes include the fact that 41.4% of the expected losses are due to commercial exposures, the fact that there is the potential for significant losses due to flood and storm surge and that the initial stated reinsurance could be eroded by covered events.

On the initial stated reinsurance, S&P explains; “The probability of attachment would be 4 basis points higher without the application of the initial stated reinsurance, and given the covered area, we typically do not experience more than one covered event within a year.”

Covered losses are for both personal and commercial lines of insurance property exposures. S&P notes that Chubb primarily markets its personal lines policies to high-net-worth individuals and is well-known for insuring high-value homes, auto, and other properties.

Named storm and hurricane risks are the major exposure with this deal, contributing 89.4% of the expected losses. Personal lines exposure makes up 58.6% of the expected loss. Due to the northeast U.S. focus of Chubb’s book of business New York makes up 40.6% of the expected losses by state, followed by Connecticut, New Jersey and Massachusetts. Around half of the total insurable value of the covered portfolio consists of coverage for professional, technical and business services.

The East Lane Re VI 2015-1 catastrophe bond features a variable reset feature, which S&P explains in more detail:

When rating nat-cat bonds that permit variable resets, we look to the highest probability of attachment permitted. At each annual reset, the expected loss can be reset within a range of 1.00%-1.50%. As a secondary reset limit, the probability of attachment cannot exceed 1.90%. Based on the current occurrence exceedence probability curve, if the expected loss were 1.50% (using the long-term rate for hurricanes), the probability of attachment would be 1.65%. The preliminary rating assumes the expected loss for each reset to be 1.50%. We do not expect the shape of the curve to change significantly, so we considered 1.65% to be the reset probability of attachment. We then looked to the related medium-term rate probability of attachment to be 1.78%. To determine the reset probability of attachment, we stressed the results and based the nat-cat risk factor off these results.

Pricing wise, the notes are being offered with coupon guidance of 3.5% to 4%, we understand, which with an expected loss of 1.24% should see a multiple well above 2.

Given where this East Lane Re VI 2015-1 catastrophe bond is set to attach, it is more risky than last years East Lane Re VI Ltd. (Series 2014-1) which attaches at $3 billion of losses to Chubb and has an expected loss of 0.82%. That deal priced at 2.75%, so the multiple looks almost aligned.

Update:

Chubb’s latest cat bond looked set to upsize, as sources suggested a range of $225m to $250m for the single tranche of notes. At the same time the coupon price guidance was narrowed from the initial 3.5% to 4% to 3.5% to 3.75%.

In the end Chubb upsized the deal and the East Lane Re VI cat bond will complete at $250m in size. The pricing however did not continue downwards and has settled at 3.75%, the upper end of the narrowed range or the mid-point of the deal’s launch coupon guidance.

In the case of this cat bond, with pricing of 3.75% and an expected loss of 1.24%, investors have secured a multiple of 3X.