We now have some more details on the latest catastrophe bond to come to market which sees sponsor State Farm seeking a new source of earthquake reinsurance protection from the capital markets via a cat bond issuance. It’s the fourth time that State Farm has gone to the cat bond market for cover directly, although they may have issued private deals as well. This latest Merna Re IV Ltd. cat bond will replace some of the cover provided by Merna Reinsurance II Ltd. which matures in April.
The cat bond is being issued through Bermuda domiciled special purpose insurer Merna Reinsurance IV Ltd. which was incorporated on the island on the 5th February, however the transaction seems to be more commonly known among those we’ve spoken to as Merna Re IV. It’s repeat sponsor State Farm’s fourth cat bond transaction, following on from 2007’s Merna Reinsurance Ltd., 2010’s Merna Reinsurance II Ltd. and 2010’s Merna Reinsurance III Ltd.
Merna Reinsurance IV Ltd. will issue at least $250m of cat bond notes on behalf of sponsor State Farm, seeking to provide a multi-year source of fully-collateralized reinsurance protection for some of its earthquake exposures. The cat bond will offer protection for earthquake risks in a number of U.S. States in which State Farm is particularly exposed, which we’re told includes the following; Alabama, Arkansas, Illinois, Indiana, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Ohio, Tennessee and Wisconsin, the same States as were covered by soon to mature Merna Reinsurance II Ltd. Given the list of covered States for this cat bond it’s clear that State Farm is seeking protection for New Madrid and surrounding areas earthquake risks, one of the zones considered to be a peak threat although more remote than some other locations in the U.S.
Merna Re IV will provide its reinsurance protection on a per-occurrence basis to State Farm and the cat bond will use an indemnity trigger based on the ultimate net losses of the sponsor. The transaction is due to have a three-year deal term, beginning at the start of April 2013 and running through until May 2016.
We understand that for losses to qualify they have to be caused by an earthquake which is USGS designated and the epicentre does not have to be within the covered area, rather the qualifying losses have to be within the covered States. This is quite typical and allows the cat bond to afford cover should an earthquake’s epicentre be deemed to fall just outside the covered area defined in the deal.
Given the New Madrid focused nature of the Merna Re IV cat bond the risks are deemed not as high as some other quake zones, such as California, resulting in a lower probability of attachment and expected loss. We’re told that the attachment point for Merna Re IV is set at $450m of ultimate net loss to State Farm and that the cat bond will cover a pro-rata share of its losses, after a 10% retention by the sponsor, up to $1.45 billion. Merna Re IV’s initial probability of attachment is said to be 0.55% while the expected loss figure is 0.40%.
In the cat bond universe this is a relatively low-risk deal with figures like that. This, combined with the diversification it offers as it does not include Californian quake risks, should make it popular with investors looking to deploy capital at this time. We’re told that pricing expectations suggest a coupon somewhere around the 2.75% mark above the return of the collateral investments, which are likely U.S. treasuries as in most other cat bond deals. The low coupon reflects the remote nature of the risks involved in this cat bond.
Given that Merna Re IV is seeking a layer of earthquake reinsurance cover for the same states as the maturing Merna Re II, there is a chance that this deal could upsize from the marketed $250m as Merna Re II provides $350m of protection.
That’s all we have on the Merna Re IV Ltd. cat bond transaction for the moment. We hope to bring you more as the deal comes to market and moves towards completion. You can read all the details we have on this and every other catastrophe bond transaction in our Deal Directory.