The CHF630m operational risk insurance linked catastrophe bond or ILS structure Operational Re Ltd. is still being marketed by global investment banking group Credit Suisse, with April now being targeted for completion and the structure split into junior and senior tranches.
This five-year CHF630m ILS transaction has been marketed to investors since February, when it first became know that the investment bank was trying to leverage the insurance-linked securities (ILS) market and the structure of a catastrophe bond as a way to secure risk capital to back its operational risk insurance needs.
The innovative transaction has been doing the rounds of investors, both in the ILS market as well as in more traditional asset management circles as well. We understand that some investors have received the proposed transaction well, while others have found it harder to quantify or even accept the broad range of operational risks the deal will cover.
Artemis can report, thanks to market sources, that the Operational Re Ltd. transaction is now being targeted for an April issuance and that the structure now features a junior and a senior tranche of notes. We should also note that we’re still calling the transaction Operational Re for now, as that was the mooted name when details first emerged, but we understand that this could be changed as it nears issuance.
We’re told that the tranching is due to feedback from some investors that they would not back the transaction without a higher coupon being paid to them, hence the split into two tranches to satisfy investor risk appetite and demand for return.
The basic premise of the Operational Re transaction remains the same. Credit Suisse will buy a CHF700m (approx $690m) operational risk insurance policy from insurer Zurich. Zurich will retain 10% of the risk of this operational risk insurance policy, while the remaining CHF630m (approx $620m) will be securitised and issued by Operational Re in now two tranches of notes to the deal’s investors.
The two tranche structure enables investors to select where to allocate capital, on a risk and return appetite basis, with the junior offering a higher coupon than the senior.
The insurance policy covers Credit Suisse’s operational risk losses above CHF3.5 billion, before which any losses are retained by the investment banking group.
The Operational Re ILS investors will be liable for aggregate indemnity of 90% of any claims against the operational risk insurance policy, so the retention held by Zurich would always take its share of the loss as well.
The junior tranche will cover the first CHF300m of losses suffered by the Operational Re ILS, while the senior will cover the remaining CHF330m, but only attaching after the junior tranche has been exhausted, we understand.
So in order for both tranches of the Operational Re ILS bond to suffer total losses Credit Suisse would have to suffer an aggregated operational risk indemnity of at least CHF4.2 billion. However, it’s important to note that no single operational risk loss could cause a loss to the notes, as the per-event limit is said to be CHF3 billion.
That means for the Operational Re ILS notes to suffer exposure to event there would have to be an aggregation during one of the annual risk periods.
We understand the two tranches of notes are now being offered with coupon guidance, with the junior tranche coming with guidance of 5.5%, while the senior coupon is said to be 4%.
The covered insurance policy has a relatively remote risk, with the expected loss said to be just 0.15%. With the ILS only taking a 90% share of losses in the policy that means the coupons on offer should prove attractive to investors, both the more traditional type and the ILS investors with an interest in this deal.
We understand that Milliman Inc. has been appointed as a risk modelling and calculation agent for this transaction.
We’re told that the investors that will back this transaction are varied, ranging from some specialist ILS investment managers, to hedge funds focused on regulatory capital opportunities, to insurance companies, family offices and also some of the world’s larger fixed income bond investment companies.
It’s encouraging to see that this operational risk ILS or catastrophe bond transaction continues to make progress. As this is an entirely new class of risk the effort to educate investors and provide them with comfort in the transaction will have been considerable.
It’s clear that Credit Suisse has taken feedback on board, with the tranching of the deal into junior and senior notes likely a response to investors appetite to be able to secure a higher coupon in return for supporting the transaction.
You can read all about Operational Re Ltd. in our catastrophe bond and ILS Deal Directory. We will update you as Credit Suisse’s operational risk insurance ILS transaction comes to market, as and when any further information emerges.