The impact of hurricane Sandy on the northeast U.S. and the expected insurance industry losses, currently estimated at $7 billion to $20 billion is a credit negative event for the Combine Re Ltd. (Series 2012-1) catastrophe bond, according to rating agency Moody’s. The current estimated range of insurance industry losses would see Sandy qualify as an event under the terms of Combine Re and further erode the cat bonds aggregate subordination layer.
The Combine Re Ltd. (Series 2012-1) cat bond was sponsored by Swiss Re America but actually provides cover for two reinsured parties, Country Mutual Insurance Company and the North Carolina Farm Bureau’s mutual insurance arm. The deal securitized $200m of multi-peril annual aggregate indemnity protection via Combine Re Ltd. It provides cover on an indemnity basis and is triggered by the ultimate net losses of the two reinsureds from the U.S. perils of hurricanes, earthquakes, severe thunderstorms and winter storms. Three tranches of notes were issued, but only two were rated by Moody’s. All three tranches of notes are exposed to all of the perils and geographic coverage locations. The transaction has an attachment point of $300m, beneath which a reinsurance retention layer provides protection before any of the three tranches of notes start to see losses.
Moody’s says that the property losses from hurricane Sandy will cause Combine Re to use up additional protective subordination and, should loss estimates rise or be at the upper end of the range, will result in losses on the cat bond. If the losses end up near the $20 billion Moody’s expects Combine Re to suffer losses. Moody’s says that a high-end loss will exceed the first loss layer meaning that the rated tranches would begin to see a loss.
Interestingly, Moody’s says it’s not clear whether Sandy will qualify as a hurricane, a severe thunderstorm or a winter storm event under the terms of Combine Re. Which type of event it is classed at has a bearing on the potential for loss to investors as losses due to hurricanes have a $200m hurricane per-event limit, while there is no limit for severe thunderstorm or winter storm. This could get interesting if it results in a dispute over the type of covered event Sandy qualified as and once again reminds us how important it is to have bullet-proof documentation and clauses in any cat bond offering.
Three events have already eroded some of the protection provided by Combine Re’s subordination layer under the COUNTRY Mutual Insurance Company book of business. Tornado and severe thunderstorm losses and also hurricane Isaac have between them eroded the attachment point down to $189.7m (from $300m) making further events more likely to trigger the rated layers of notes and cause principal losses to investors.
Moody’s notes that in their opinion none of the other cat bonds they provide ratings for is at risk as Globecat Ltd., EOS Wind Ltd., Vega Capital Ltd. (Series 2010-I), Successor X Ltd. (Series 2012-1) and Mythen Ltd. (Series 2012-1) are all structured to trigger on a per-occurrence basis. Moody’s don’t expect hurricane Sandy to threaten any of these bonds.
Given the discussion of the creeping loss estimates for Sandy it’s beginning to look likely that the final industry loss could be towards the upper end of the currently estimated range. Whether it will cause a loss to Combine Re is at this time impossible to tell, but we feel it is likely that a further update will come out when the impact is better understood in which Moody’s will likely detail the amount that the subordination layer has been eroded, whether a rating change is required and whether it will affect investors.
Interestingly, while Combine Re pricing had declined a little it hadn’t seen particularly large changes in bid or offer prices last week, suggesting that investors were relatively happy it was safe. We suspect that the bids may reduce somewhat after this announcement.