Clariden Leu transforms industry loss warranties into catastrophe bonds

Clariden Leu have closed another of their ‘cat bond lite’ transactions which see’s them privately arranging an issuance of catastrophe bond notes to investors through an innovative transaction at a time when the cat bond market is not meeting investor demand. They first utilised this cat bond lite structure back in October last year to secure $20m in additional cat bond capacity for their investment funds.

Primary market catastrophe bond issuance has been slow in recent months at a time when investor demand has been growing for the asset class. The lack of supply has recently forced Clariden Leu to close their flagship cat bond fund to new subscriptions for the second time in less than a year. These cat bond lite transactions have given Clariden Leu a way to continue to add new capacity to their funds and sell cat bond notes to investors at a time when the primary market isn’t fulfilling their needs.

This latest transaction which Clariden Leu closed on the 10th June saw them take an industry loss warranty (ILW) and transform it into $50m of transferable securities. This has enabled them to provide much needed capacity for their funds and sell some of the notes to private investors directly.

Clariden Leu explained that ILW’s, as direct reinsurance investments, do not meet the regulatory requirements of the European regulators for their cat bond funds. Open-ended regulated cat bond funds such as their Clariden Leu (Lux/UCITS III) Fund can only invest in liquid cat bonds or insurance-linked securities. Exchange traded derivatives, such as IFEX or CME hurricane derivative contracts, are not accepted and deemed to be non-UCITS assets and subject to certain limitations.

Hence the cat bond lite structure. Through this structure Clariden Leu have transformed a standard industry loss warranty into a security which can be transferred and which meets all regulatory requirements for public insurance-linked securities funds. They arranged the deal, acted as lead manager, provide the pricing for the instrument and act as a market maker in this respect. Fund administrators can retrieve pricing information through Bloomberg for the notes.

The deal ultimately provides protection to a reinsurer, who remains unknown. The transaction provides this reinsurer with cover against 3rd event Florida hurricanes and requires three events to trigger a payout, with one event exceeding $3 billion, one event exceeding $4 billion and one event exceeding $5 billion in losses. The events can occur in any order over the duration of the transaction which provides cover from 10th June to 31st December 2011.

Michael Stahel, Head of Insurance-Linked Investments at Clariden Leu said; “The goal of the transaction was to do a non-first event US windstorm deal as such risk is very difficult to access through the cat bond market at this stage. By transacting a 3rd event Florida windstorm ILW into a derivative transaction, the “cat bond light” optimally fits into the portfolios of the pure cat bond strategies of Clariden Leu.”

The transaction was for $50m in capacity and as an investment opportunity was broken down into 50,000 certificates valued at $1,000 each. These certificates can be transferred and therefore traded on the secondary market. The product has been fully placed in the market with Clariden Leu themselves being the majority investor (placing the capacity within their funds) and some being sold to private capital markets investors.

Here’s some details on the way the transaction was structured:

Structural Set-Up of 'Cat Bond Lite' - Click for larger version

• Insurance/Reinsurance company buys event protection in pure swap form from Clariden Leu Ltd (using ISDA contract framework; index-based structure only – PCS or PERILS)
• Clariden Leu Ltd issues certificates (transferable security with ISIN/CUSIP)
• Investors invest in certificates (dedicated cat bond funds)
• Clariden Leu offers full daily liquidity on certificate (price feed via Bloomberg)
• If natural catastrophe occurs: Clariden Leu Ltd pays notional limit with no return to investors
• If no natural catastrophe occurs: ISDA contract is terminated with full pay-back to investors
• Clariden Leu Ltd acts as structurer and market-maker; actual event risk is taken on by investors

These private market catastrophe bond transactions are becoming an efficient way for investment managers and funds to provide opportunities to their clients at a time of limited ILS market capacity. We expect to see further private market issuances and suspect that this type of offering could become much more popular for large entities such as hedge funds who want to ‘create’ investment opportunities within the catastrophe-linked sector.