Cranberry Re Ltd. (Series 2015-1) – Full details:
For this transaction Hannover Rück SE is sponsoring the catastrophe bond on behalf of the reinsured, Massachusetts Property Insurance Underwriting Association (MPIUA), using newly established Bermudian special purpose insurer Cranberry Re Ltd.
Cranberry Re Ltd. will issue a single tranche of Series 2015-1 Class A notes, currently proposing a $200m issue, which will be sold to investors to collateralize a reinsurance agreement between the MPIUA and Hannover Re.
The notes will ultimately provide the MPIUA with a fully-collateralized source of reinsurance protection against losses from State of Massachusetts named storms (so tropical storm and hurricane risks, severe thunderstorms and winter storms.
The protection from the Cranberry Re 2015-1 cat bond notes will provide protection on an indemnity and annual aggregate basis over a three-year period, covering any losses suffered under the reinsurance agreement between the pre-defined attachment and exhaustion levels.
The Cranberry Re 2015-1 Class A notes will have an attachment point at $300m of losses and an exhaustion point set at $1.4 billion, suggesting the notes will only cover a percentage of the MPIUA’s losses within that layer of its reinsurance programme.
The initial attachment probability will be 3.081%, the initial exhaustion probability 0.697% and the expected loss 1.377% on a base case (1.383% sensitivity case).
We understand that the Cranberry Re 2015-1 notes will be marketed with a coupon guidance range of 3.8% to 4.3%, suggesting a multiple of around 3 times the expected loss.
Fitch Ratings has already published a pre-rating note on the bond, in which it provides the following details:
The MPIUA represents a total insured value of $97.5 billion or a 12% market share (based on 2013 premium). The subject business consists of homeowners (91%) and dwelling coverage (9%) with very minimal commercial coverage (<1%).
Significant coastal counties; such as Barnstable (Cape Cod area) and Suffolk (Boston area), have the largest exposure at 29.5% and 14.6%, respectively. Other notable coastal counties, Dukes (Martha’s Vineyard area) and Nantucket, have 4.8% and 3.2% of the total insured value, respectively.
A covered event within the risk period, July 1, 2015 through June 30, 2018, must cause at least $10 million of ultimate net loss to MPIUA to qualify. Notable recent events would be considered a covered event but not significant to cause a principal loss to the Series 2015-1 Notes. Of the multiple winter storms in 2014 and the first quarter of 2015, the only covered event has an estimated $14.4 million of incurred claims.
Recent ‘named storms’ Superstorm Sandy (October 2012) had total losses of $10.1 million and Hurricane Irene (August 2011) would not have qualified. The most damaging event caused by wind and thunderstorms occurred in May 2011 and had $16.8 million of total paid losses.
Initially, noteholders are subject to principal loss (and reduced interest) if the annual aggregate ultimate net losses exceed the attachment point of $300 million and a total loss of principal occurs if the severity reaches $1.4 billion in the first twelve-month risk period. Based on the profile of the subject business and the attachment point, the third party modeling firm AIR Worldwide (AIR) calculates the modeled annual attachment probability to be 3.081%, which implies a ‘Bsf’ rating per Fitch’s criteria. It should be noted that the threshold between a ‘B’ and ‘B+’ rating is 3.02% (in other words, Fitch may have rated the note ‘B+’ if the attachment probability was slightly lower). The modeled expected loss is 1.377%.
There will be three annual risk periods over the term of the notes, with the ‘reset’ occurring on July 1, 2016 and July 1, 2017 using AIR’s escrowed software models and MPIUA’s updated subject business data and loss adjustment expense factor. At each reset date, MPIUA may exercise an option to decrease (or increase) the attachment levels within a rather wide exceedance probability range of 4.00% to 1.50%. The implied rating under Fitch’s criteria at a 4.00% exceedance probability is ‘Bsf,’ and the implied rating at 1.50% is ‘BB-sf’. If such an option is exercised by MPIUA at either reset date, the risk interest spread will be recalculated to reflect the increased (or decreased) level of risk assumed by the noteholders. If MPIUA does not elect to reset the attachment levels, the reset agent will adjust the attachment level and exhaustion level to maintain the initial 3.081% exceedance probability using the updated subject business profile.
The notes may be extended for 36 additional months if certain qualifying events occur, or at the discretion of Hannover Ruck SE, a reinsurance company that acts as a transformer and sits between MPIUA and Cranberry Re. However, the notes are not exposed to any further catastrophe events during this extension (only further claim development of existing events). The notes may be redeemed at any time due to regulatory or tax law changes or partially by MPIUA during the extension period or under certain early redemption events. The repayment of the notes to the noteholders occurs subsequent to any qualified payments to MPIUA for covered events. Noteholders have no recourse to MPIUA (or to its transformer, Hannover Ruck SE).
KEY RATING DRIVERS
The rating is based on the evaluation of the natural catastrophe risk, the business profile of MPIUA, the counterparty risk of the transformer reinsurer (Hannover Ruck SE) and the credit risk of the collateral assets. The natural catastrophe risk represents the weakest link and currently drives the rating of the Series 2015-1 Notes.
The rating analysis in support of the evaluation of the natural catastrophe risk is highly model-driven. As with any model of complex physical systems, particularly those with low frequencies of occurrence and potentially high severity outcomes, the actual losses from catastrophic events may differ from the results of simulation analyses. Fitch is neutral to any of the major catastrophe modeling firms that is selected by the issuer to provide the modeling analysis, and thus Fitch did not include any explicit margins or qualitative haircuts to the probability of loss metric provided by the modeling firm.
The probability of loss was initially estimated at 3.081% based on 100,000 simulations of a one-year risk period as calculated by AIR using their methodology and proprietary models (Version 16.0 of the AIR Hurricane model for the United States, version 7.0 of the AIR Severe Thunderstorm model for the United States, version 1.7 of the AIR Winter Storm model for the United States, each as implemented in Touchstone version 2.0.2). Results from other possible modelers or from MPIUA were not provided. Sensitivity analysis provided by AIR indicated the implied rating would be no worse than ‘Bsf’.
The model estimates ‘named storms’ contribute 96.3% of the annual expected loss, with winter storms and severe thunderstorms being 2.2% and 1.5%, respectively. In addition, of the simulated years that produced aggregate ultimate net losses exceeding the attachment level, 49.8% are attributed to a single event in the year, while years with two events would represent another 32.9%. Within the record of actual historical events, only four hurricanes (if replicated and applied to the current subject business) would lead to a partial principal loss – notably, Hurricanes Donna (1960) and Bob (1991) would have produced a 27.4% and 20.0% principal loss.
The risk modeling included certain stresses for economic demand surge, storm surge and a loss adjustment expense factor of 1.065. The modeled results did not include the possibility that the average annual loss may increase by up to 1.10 in any annual risk period. The model simulates only hurricane activity making landfall, thus it understates claim losses to named storms not recognized as hurricanes or hurricanes that become degraded. Noteholders are exposed to this basis risk or the difference between actual net losses incurred by MPIUA and the AIR modeled net losses.
Cranberry Re Ltd. ultimately ‘follows the fortunes’ of MPIUA in regards to underwriting of new business over the next three years and claim management practices. MPIUA was established by the Massachusetts Legislature in 1968 as a residual insurer of last resort solely for the Commonwealth of Massachusetts and employs approximately 150 people. It is a for-profit organization organized by an association of over 500 member insurers. Business can be placed by licensed agents, brokers or directly by consumers. All properties insured by MPIUA must be certified as built to specified building codes, must have flood insurance coverage in specified flood areas and have maximum limits per residential dwelling of $1,000,000 (higher limits are available for commercial structures).
Fitch does not rate MPIUA but believes certain safeguards are in place for noteholders. MPIUA is subject to review, oversight and approval by the Massachusetts Department of Insurance (though it receives no federal, state or local funds for support); there is an independent claim reviewer and loss reserve specialist (Towers Watson Ltd., Bermuda) for Cranberry Re Ltd.; and the data quality of the Subject Business provided to AIR appears good. For this particular peril and transaction, MPIUA will retain at least 5% of the aggregate ultimate net loss on a first-dollar basis, covering the first $100 million.. Above this retention, claim losses are paid by traditional reinsurers until reaching the attachment point, where losses are shared between noteholders and reinsurers on a pro-rata basis depending on the ultimate deal size.
Hannover Ruck SE (IDR: ‘AA-‘; Rating Outlook Stable by Fitch) acts as the transformer for MPIUA and Cranberry Re Ltd.. Noteholders are exposed to the counterparty risk that Hannover Ruck SE does not pass along retrocession premiums to Cranberry Re Ltd.. These premiums are a key component in the coupon payment to noteholders.
Proceeds from this issuance will be held in a collateral account and used to purchase high-credit-quality money market funds meeting defined eligibility criteria, otherwise funds will be held in cash. Investment yields generated from these permitted investments are passed directly to noteholders as the other component. Noteholders are exposed to possible market value risk if the net asset value of a money market fund falls below $1.00. Finally, certain actions may be required if the collateral account is invested in money market funds and FATCA is deemed to apply in late 2016.
This rating is sensitive to the occurrence of a qualifying event(s), MPIUA’s election to reset the note’s attachment level, changes in the data quality or purpose of MPIUA, the counterparty rating of Hannover Ruck SE and the rating on the assets held in the collateral account.
If qualifying covered events occur that cause annual aggregate losses to exceed the attachment level, Fitch will downgrade the notes reflecting an effective default and issue a Recovery Rating.
In the case of a reset election by MPIUA, the rating would not be sensitive to a movement from the initial 3.081% exceedance probability to a probability as high as 4.00%, since both probabilities imply a ‘Bsf’ rating. However, if MPIUA elected to move closer to an exceedance probability approaching 1.50%, the notes at that time could be upgraded to as high as ‘BB-sf’.
To a lesser extent, the notes may be downgraded if the money market funds should ‘break the buck’, Hannover Ruck SE fails to make timely retrocession premium payments or MPIUA materially changes its mission or operations.
The escrow model may not reflect future methodology enhancements by AIR which may have an adverse or beneficial effect on the implied rating of the notes were such future methodology considered.
Fitch’s expected rating is based on a review of a draft Confidential Offering Circular Supplement No. 1 (dated March 24, 2015), a Rating Agency Presentation (dated March 24, 2015) and AIR Expert Risk Analysis and Results (dated March 25, 2015). The final rating is contingent upon receipt of signed legal documents pertinent to this transaction that do not materially change what has currently been reviewed. Any changes could lead Fitch to an alternative rating or inability to rate the note.
Thanks to ILS investor demand the single tranche of Cranberry Re Series 2015-1 Class A notes have upsized by 50%, to now offer $300m of risk to investors.
Coupon price guidance for Cranberry Re launched with a range of 3.8% to 4.3%. Artemis understands that this has now been set to the bottom of the launch range, offering investors a 3.8% yield.
With an expected loss of 1.377% on a base case (1.383% sensitivity case), the coupon of 3.8% will provide investors with a multiple of 2.8x (base case) or 2.7x (sensitivity case).