Nelson Re catastrophe bond investors no longer facing losses, or are they?

Some confusion has come to light over the Nelson Re Ltd. catastrophe bond which was thought to have been triggered and to have lost close to $27m of investors principal. Back in July, sponsor Glacier Re had reported a proof of loss which would have seen investors only recover 60.6% of the $67.5m tranche of Class G notes, but now questions have been raised about the validity of some of the claims making up the submitted proof of loss estimate.

Moody’s, who rate the Nelson Re cat bond deal, have published an update which gives a timeline of events since July and helps to make the status a little clearer. A few days ago Nelson Re was extended again but there was little explanation which lead us to believe it was for further losses to develop, now it transpires that it has actually been extended for the previously submitted loss estimates to be double checked for validity under the terms of Nelson Re.

The deals administrator, Deloitte & Touche Ltd. Bermuda, were required to independently verify the proof of loss that Glacier Re had submitted. Usually this is a formality and nothing changed, however in the case of Nelson Re they have been unable to complete that task as Nelson Re and Glacier Re have been unable to agree whether certain policies actually were covered under the deals reinsurance agreement.

Here’s a shortened version of the timeline:

15th July 2011: Glacier Re submit the proof of loss which shows Nelson Re investors to be liable for nearly $27m of claims. The proof of loss goes off to be verified by the deals administrator.

15th August 2011: Deloitte & Touche issues a letter saying they are waiting for further information from Glacier Re so that they can re-calculate the ultimate net loss and what would be payable by investors.

25th August 2011: Deloitte & Touche issue another letter saying that they are unable to calculate the loss as they are, and we quote from Moody’s report: “Awaiting resolution between Nelson Re and Glacier Re on whether certain underlying policies that incepted in 2008 prior to June 7, 2008, and which were not initial modeled contracts, are covered under the reinsurance agreement.”

26th August 2011: Deloitte & Touche issued another letter saying that they couldn’t complete the calculations and hence could not validate Glacier Re’s request for reduced interest payments.

29th August 2011: Glacier Re extend the agreement with Nelson Re for another three months until 6th December. We assume this is so they can continue to try to validate their proof of loss.

So, what does this mean for the Nelson Re cat bond which everyone assumed faced a loss? Well, Moody’s say that Nelson Re and their bondholders are currently not liable for any loss and their ratings on the deal remains the same. Meanwhile Nelson Re and Glacier Re are continuing to try to resolve the question over the underlying policies and whether they are actually covered under the terms of the Nelson Re cat bond deal.

This interesting situation is one which should not really happen if a deal is well structured and the covered policies are well defined. This should serve as a lesson to anyone issuing or structuring catastrophe bonds (or even reinsurance contracts), make sure it is explicitly clear what is covered under the terms of the deal, sometimes the reams of paperwork created during a deal can be your friend.