Long Point Re III Ltd. (Series 2013-1)

This latest cat bond from Travelers is similar to its 2012 transaction. This deal will see Long Point Re III Ltd. issue a single tranche of Series 2013-1 cat bond notes, which has a preliminary size of $150m, designed to protect it against hurricanes in northeastern U.S. states on an indemnity and per-occurrence basis.

The actual beneficiaries of the cat bond protection are the Travelers Indemnity Co., Travelers Casualty and Surety Co., St. Paul Fire and Marine Insurance Co., and The Standard Fire Insurance Co., together with direct and indirect insurance subsidiaries.

The covered business is from Travelers personal-lines and commercial-lines insurance business. The commercial-lines business is a mix of Travelers’ select accounts (small business policies) and commercial accounts (midsize business policies). Business units that cover large and unique exposures, complex financial structures, and mobile property have been excluded from the subject business.

The covered area is; Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont, Virginia, and the District of Columbia.

The 2013-1 tranche of cat bond notes are riskier than last years 2012-1 issuance. The 2012 deal had an Ultimate Net Loss (UNL) attachment point of $2 billion, while this 2013 cat bond has an attachment point of $1.25 billion and an exhaustion point of $1.8 billion. The is a limit of $20m loss per risk.

The attachment probability for the notes will be 1.416% in the first year, while the exhaustion probability will be 0.952% and the expected loss 1.159%. The 2012 deal had an attachment probability of 0.89%, a probability of exhaustion of 0.71% and an expected loss of 0.81%.

This 2013-1 deal covers 54.55% of a layer beneath the Long Point Re III Ltd. (Series 2012-1) which attaches at $2 billion of losses.

The transaction will have a term of three years, with maturity expected in May 2016. We understand that the reinsurance transaction that underlies this cat bond also includes a clause that will see Travelers retain 10% of any qualifying losses.

GC Securities, who acted as joint bookrunner on this transaction, noted that the deal enhanced the protection that Travelers receives from the capital markets through the addition of a number of new features which provide flexibility to the sponsor. This includes an expanded definition of hurricanes, this has been worded to include and storm reported by any agency at any time to be a hurricane and also includes storms which may merge with other systems. This new definition would ensure that the cat bond covered a storm such as hurricane Sandy.

We also understand from sources that this Long Point Re III cat bond has provisions for a variable reset which allows the sponsor, Travelers, to adjust the trigger amount as long as the expected loss remains between 1% and 1.5%. If Travelers chose to do that we assume that the coupon that investors will be paid would be adjusted to reflect the increased risk as well.

If Travelers choose to use the variable reset the UNL attachment point could move to as low as $930 million.

The bond also features a call option allowing Travelers to redeem the cat bond, for a small above par penalty. This would allow the insurer to swap the cover back to traditional reinsurance sources if the pricing was attractive enough to offset the penalty.

Standard & Poor’s explained in it’s pre-sale report; “The call option also affects the selection of an attachment point when there is volatility in reinsurance prices. Travelers can redeem the bond at 103% of par after year 1 and at 102% of par after year 2. When prices drop by enough to absorb these penalties and offset their transaction costs, Travelers has an incentive to call the bond. Conversely, when reinsurance prices rise, Travelers would like to see this bond cover as much of its losses as possible. Although its coupon would rise if more risk were pushed into the layer, the magnitude of the coupon adjustment is based on current market conditions. Thus, Travelers would find this bond a comparatively good deal and would want more losses covered by the structure. This means lowering the attachment point and setting the bond’s expected losses at the upper end of the permissible range.”

One historical event could have caused a total loss of principal to the notes, 1938’s “Northeast Clipper” that made landfall initially in New York, with losses that would have reached the attachment level. The AIR estimated net loss from this event was $2.566 billion, which would have resulted in a total loss of principal.

Long Point Re III will deposit the proceeds from the sale of the notes into a reinsurance trust account. These must be invested in assets according to a stated priority. The first category in which funds must be invested subject to availability is money-market funds domiciled in the U.S. that invest solely in treasury obligations and that are rated ‘AAAm’ by Standard & Poor’s on the issuance date and are not subject to U.S. or foreign withholding tax.

Update: This cat bond deal doubled in size to $300m while marketing and the pricing dropped to the bottom end of the marketed range to 4%.