Florida’s Citizens Property Insurance Corporation is one of the first catastrophe bond sponsors to opt to use a variable reset facility with its Everglades Re Ltd. (Series 2013-1) catastrophe bond, by choosing to lower the attachment point.
The $250m Everglades Re 2013-1 cat bond, which Citizens sponsored back in March 2013, featured one of the first reset mechanisms to allow for a change to the attachment point, attachment probability and as a result the interest spread paid to investors in the bond.
Citizens has the option to move the layer of reinsurance protection provided by the Everglades Re 2013-1 cat bond, as long as the attachment probability remains within a range of 2.75% to 3%. The attachment probability of the single $250m tranche of notes at launch was 2.91%.
At the first reset, effective June 1 we believe, Florida Citizens has chosen to drop the layer of protection provided by Everglades Re 2013-1 down a little in its tower, lowering the attachment point from the $5.139 billion of indemnity losses by $243m down to $4.896 billion.
Given the record $1.5 billion Everglades Re 2014-1 has an attachment point at $5.202 billion this makes perfect sense. By dropping the 2013 cat bond layer down a little it stretches the amount of its overall protection from cat bonds to begin at the new Everglades 2013-1 attachment of $4.896 billion, covering most of the way up to the exhaustion point of Everglades Re 2014-1 at $7.702 billion.
This is the whole point of the variable reset feature, of attachment probability, in catastrophe bonds. It affords the sponsor a level of flexibility, allowing the coverage to be moved up and down in order to best fit alongside other forms of reinsurance and risk transfer.
The new probability of attachment, after the reset, is 2.75%. This is the bottom end of where it could be moved to and a lower attachment probability typically indicates a less risky bond. The fact the attachment probability has fallen, indicating possibly a lower risk bond, but the attachment point has been lowered, typically indicating a higher risk bond, may be a little confusing and deserves some explanation.
It’s important to remember who the sponsor is here. Florida Citizens is undergoing depopulation, offloading chunks of policies to existing and startup primary insurers to pass risk and policies back to the private insurance market. Much of this takeout or depop activity is in the Citizens coastal account, where the cat bonds cover is focused. So the underlying portfolio is changing and as a result the reset numbers can look a little unusual.
It’s probably best to think of the reset in terms of the probability of attachment, rather than the attachment point, as that shows the risk has dropped a little which is likely a better reflection of the true risk/return of the Everglades Re 2013-1 cat bond given the changing portfolio.
Standard & Poor’s Ratings Services said that it has affirmed its ‘B(sf)’ rating on the Everglades Re Ltd. (Series 2013-1) Class A notes after the reset. However, S&P notes that using a sensitivity case analysis, the probability of attachment following the reset is 3.13%; after adjusting this probability of attachment based on transaction-specific factors, S&P said the natural catastrophe risk factor of the bond would be ‘B+’.
S&P also said that it reviewed the creditworthiness of Citizens as well as its ratings on the collateral which would be used to redeem the principal at redemption as long as no events occur, which is apparently Goldman Sachs Financial Square Treasury Instruments Money Market Fund #506 (‘AAAm’).
In 2015, when the final reset is reached, S&P said that if the probability of attachment is reset to 2.75% it could raise its rating on the notes to ‘B+(sf)’. Whether this happens depends on other factors, such as the sensitivity-case probability of attachment, the shape of the occurrence exceedance probability curve, any changes in the modeling, the creditworthiness of the ceding company, and the rating on the collateral, among others, explained S&P.
So, this is among the first (may be the first) variable reset of a catastrophe bond that we’ve heard of and definitely the first for a rated bond where information is available to report to our readers. Citizens continues to leverage its cat bond cover in an intelligent way, moving the attachment down to maximise its cat bond protection. The Everglades Re cat bonds now provide cover across a large section of the Citizens reinsurance programme tower.
The final thing to note is that the interest spread paid to investors will have changed slightly. The deal paid a 10% coupon at launch. According to the terms of the variable reset, the new interest spread is calculated as: (the initial interest spread X new probability of attachment) divided by the original probability of attachment. Working that out comes to approximately 9.45% which would support a slight drop in riskiness of the bond.