Yesterday we wrote that U.S. insurer Travelers had successfully completed their latest catastrophe bond Long Point Re III Ltd. but today we’ve seen that Travelers 2009 issue cat bond Longpoint Re II Ltd. is a cause for some concern for the firm. Cat bonds usually contain clauses that state the triggering parameters such as attachment point and exhaustion point have to be reset on an annual basis to reflect the latest risk model data and the underlying portfolio of risk which is being transferred. Longpoint Re II has recently undergone its annual reset with interesting results.
An article in the Insurance Insider publication alerted us to the recent reset of the Longpoint Re II cat bond on the 1st May. Travelers latest annual report document (which you can download here) discusses their catastrophe reinsurance provisions including their catastrophe bond cover and the recent reset.
The Longpoint Re II cat bond was issued using the RMS risk model in 2009. Since then RMS launched a new version of the risk model, RMS v11, and so at the recent annual reset this new model was used. Now as readers will be aware the RMS v11 model has an enhanced view of U.S. hurricane risk and at the time of its launch caused many cat bonds to experience large increases in expected loss numbers when they were run through it. This led Standard & Poor’s to reassess the ratings on a number of cat bonds, including Longpoint Re II although the two tranches of Longpoint Re II were not actually downgraded as the impact to expected losses was not seen as sufficient to warrant that.
Now, Travelers say that when the Longpoint Re II cat bond was reset using the latest version of the model it is estimated that it will increase their attachment point by around 70%, quite a jump. When Longpoint Re II came to market it had an attachment point of $2.25 billion of index-based losses. It was reset on 1st May 2011 and the attachment point from that time to 30th April 2012 was actually slightly lower at $2.208 billion. Travelers say that they have not yet determined the state weightings for the latest reset but they say “It is estimated that the attachment point for the index-based losses and the maximum limit on the reinsurance agreements in the Longpoint Re II program will increase by as much as 70%, reflecting increases in the third-party model’s industry estimate of covered losses.”
Now, if the attachment point rises by that much it stands to reason that the risk of the cat bond attaching is actually slightly lower as it would take a greater amount of losses to breach the reset attachment point and therefore a larger, or more impactful, catastrophe event. This is unusual as the expectation had been that the new RMS model would raise the expected loss of cat bonds, and hence a number were downgraded. If this deal had become more risky we would expect a ratings statement from S&P, we can’t rule that out yet as these numbers are currently estimated, but with an increased attachment point it seems unlikely at this time.
However, what this change in attachment point would do is leave Travelers with a potential exposure in their catastrophe reinsurance program. Insurers layer their cover to ensure they have reinsurance protection where required and retain losses where they are financially able to. This jump in attachment point could leave Travelers with a gap in their reinsurance cover and hence an unexpected layer where they are currently at risk of retaining a greater amount of potential losses. Travelers said that they; “May seek additional catastrophe reinsurance coverage, either through general catastrophe reinsurance or through catastrophe bonds, to provide protection against the higher potential retention of catastrophe losses resulting from the expected increase in the attachment point.”
Travelers latest cat bond Long Point Re III which completed yesterday provides $250m of cover between an attachment point of $2 billion and an exhaustion point of $2.5 billion so won’t cover the total gap that this reset may leave them with. So Travelers may have to look to either the traditional reinsurance markets or the non-traditional markets, perhaps with another catastrophe bond, to plug the gap in their reinsurance program. Timing could be an issue though as whatever cover they choose to acquire it will likely cost them more during the hurricane season than it would have if they’d completed it beforehand.
We’ll update you if we hear anymore on this interesting development with Longpoint Re II.