Residential Reinsurance 2013 Ltd. (Series 2013-1)

Residential Reinsurance 2013 Limited is a recently registered Cayman Islands domiciled Class C insurer established by USAA to issue series of catastrophe bond notes.

This first Series 2013-1 issuance by Residential Re 2013 is designed to provide sponsor USAA, and certain affiliated companies, with a source of fully-collateralized indemnified risk transfer via a reinsurance agreement.

The deal uses an indemnity trigger and will provide a source of both per-occurrence protection and aggregate protection to USAA for personal-lines losses over a four-year risk period for the perils of U.S. hurricane, U.S. earthquake, U.S. severe thunderstorm, U.S. winter storm and California wildfire within the covered area.

The transaction is being marketed with a preliminary size of $250m and is split into two tranches of notes, a tranche of Class 3 notes sized at $95m which provide protection on a per-occurrence basis and a tranche of Class 11 notes sized at $155m which provide protection on an annual aggregate basis.

The risk period is for four years of cover, beginning the 1st of June 2013 and the deal will mature at the end of May 2017.

The $95m Class 3 per-occurrence tranche of notes cover a percentage of losses between an attachment point of $1.356 billion and an exhaustion point of $2.057 billion. The Class 3 notes have an attachment probability of 4.75%, an expected loss of 3.26% and an exhaustion probability of 2.27%.

The $155m Class 11 annual aggregate tranche cover a percentage of losses between an attachment point of $1.075 billion and an exhaustion point of $1.593 billion. These notes have an attachment probability of 4.55%, an expected loss of 2.1%, an exhaustion probability of 0.85%.

The Class 11 notes are less risky despite having a lower attachment point because they have a franchise deductible applied, so that only events causing an ultimate net loss of $50m or greater can be aggregated towards the trigger point. The Class 3 notes do not have a franchise deductible but do require USAA to retain at least 10% of losses from its occurrence layer of reinsurance.

Historical loss modelling for the Class 3 per-occurrence notes show that one historical hurricane and three historical earthquakes generated ultimate losses that would have reached the attachment point for that tranche; the 1938 “Northeast Clipper” hurricane ($1.626 billion), the 1906 San Francisco earthquake ($1.972 billion), the 1812 New Madrid earthquake ($1.828 billion), and the 1886 Charleston earthquake ($1.502 billion). None of these events would have reached the exhaustion point however, so only would have caused a partial loss of principal to investors.

For the Class 11 aggregate notes we understand that no single year on record has seen aggregate ultimate net losses high enough to breach the attachment point.

The U.S. hurricane and tropical cyclone covered area includes the following states; 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. Earthquake coverage is for all 50 states and the District of Columbia. However, losses caused by fire following will not be covered in Hawaii or Alaska. Severe thunderstorms and winter storms coverage is for the 48 contiguous states and the District of Columbia. Wildfire protection is in California only.

Reporting agencies used for each peril are the National Hurricane Center for U.S. hurricane and tropical cyclones, the U.S. Geological Survey for earthquakes and Property Claims Services (PCS) for severe thunderstorm, winter storm and wildfire. With PCS acting as reporting agency it means that for an event to qualify for those perils it would have to have been designated a catastrophe event by PCS.

The proceeds from the sale of the two tranches of notes will be deposited in a reinsurance trust account and then invested in highly rated Treasury or Federal money-market funds.

The Class 3 tranche of notes are being marketed with a coupon guidance range of 9.75% to 10.5%.

The Class 11 tranche of notes are being marketed with a coupon guidance range of 8.5% to 9.5%

Update: During the marketing stage of this deal the transaction increased in size from $250m to $300m. The Class 3 notes remained at $95m but the Class 11 notes grew from $155m to $205m in size.

At the same time the price guidance for the notes was reduced. The Class 3 notes began marketing with a coupon range of 9.75% to 10.5% but are now being offered with a range of 9.25% to 9.75%. The Class 11 notes have experienced a similar drop in pricing, reducing from the original range of 8.5% to 9.5% to now offer a spread range of 8% to 8.5%.

Update 2: The pricing on this transaction dropped to the bottom end of the already reduced ranges. The Class 3 notes priced at the bottom of the reduced range at 9.25%. That’s a drop in the risk spread on these notes of approximately -9% from the mid-point of the originally marketed range.

The Class 11 notes also priced at the lower end of the reduced range, at 8%. That equates to a drop in risk spread of around -11% from the mid-point of the coupon pricing range these notes launched with.