In 2018 we see the insurance-linked securities (ILS) market expanding further into new classes of risk, as evidenced by the emergence of a new transaction named Fidus Re Ltd. (Series 2018-1) which is a vehicle for transferring financial guarantee insurance risks to the capital markets.
Fidus Re Ltd. is a Bermuda special purpose insurer (SPI) established to issue and sell notes to investors with the proceeds used to collateralize excess of loss reinsurance agreements between Fidus Re and the sponsor, which is financial guarantee specialist insurer Build America Mutual Assurance Company.
We understand that a single $100 million tranche of notes are being offered to investors, some of which are destined to be ILS funds and the typical ILS suspects, but we’re also told that the investor base for a financial guarantee ILS transaction could be a little broader, as other specialist investors may be attracted to the deal.
Fidus Re Ltd. will issue a $100 million Class A tranche of notes. The notes will have a twelve-year term, so will provide the sponsor with reinsurance across a long duration. The notes are callable after five years, we understand.
The notes will provide reinsurance against losses on a pre-defined portion of Build America Mutual Assurance Company’s financial guarantee insurance portfolio, and will cover losses on an aggregate basis above an attachment point of $165 million of losses.
The covered portfolio includes 95% of Build America Mutual’s U.S. public finance financial guaranty policies issued through December 31st 2017, but excludes any surety policies and all exposures rated below investment grade, according to Kroll Bond Rating Agency which has rated the Class A notes as ‘AA’ grade.
Kroll also explained that only those amounts of insured principal and interest that come due through the 12 year term are covered under the reinsurance agreement, to the extent losses during this period exceed $165 million.
The covered portfolio is granular, geographically diverse, and is not exposed to higher risk sectors of the U.S. municipal market such as healthcare, housing, and private higher education, Kroll also said.
Build America Mutual only guarantee’s U.S. municipal bonds from issuers that deliver essential public services, so the bonds themselves are typically lower risk, lower volatility and has a higher credit rating.
Given the risks covered this is of course not an ILS transaction where the resulting asset can be said to have a very low correlation with broader financial factors, given the underlying insurance covers the risk of municipal bond defaults.
Build America Mutual will take its share of any losses within the layer of reinsurance that Fidus Re covers.
Fidus Re will cover 90% of all net paid claims exceeding the $165 million attachment point up to a maximum payout of $100 million, while Build America Mutual will pay the remaining 10% share.
It’s a clever way to diversify sources of reinsurance protection for the sponsor, tapping into fully-collateralized reinsurance protection from the capital markets and leveraging investor appetite for insurance-linked bond issuances.
The fact this ILS deal contains a new class of risk in financial guarantee is also encouraging, as it signals increasing maturity within the ILS market and the ability of certain investors to expand their horizons further beyond pure catastrophe exposures.
The financial guarantee nature of the underlying risks mean that not all ILS funds and investors will be attracted to the Fidus Re notes, or able to invest because of their mandates which are often catastrophe focused and the fact this is not as low correlation with economic factors. But the notes will likely suit some investors and also help to broaden the knowledge of the ILS asset class further as well.
Most encouraging is the fact that if this transaction is successful it could open up the ILS and capital market to a new group of sponsors that would benefit from access to a diversified source of efficient reinsurance capacity.