Swiss Re Insurance-Linked Fund Management

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Mexico’s upper target for new World Bank cat bond lifted to $525m


The upper-end target for the government of Mexico’s latest World Bank supported catastrophe bond issuance has been lifted, with the IBRD / FONDEN 2020 transaction now seeking up to $525 million of parametric earthquake and hurricane protection for the country.

mexico-flagAs well as up uplift in the upper-end of its targeted size, this latest catastrophe bond for Mexico has seen pricing rise towards the top-end of guidance or even higher across most tranches, reflecting ILS investor demands for higher spreads.

The sixth catastrophe bond transaction to benefit Mexico, this new issuance that the country is sponsoring with the assistance of the World Bank and its International Bank for Reconstruction and Development (IBRD) is also the first catastrophe bond to incorporate sustainable development bond features within the structure.

When the transaction was launched to investors a fortnight ago, the issuance was offering $425 million of notes linked to the two perils of Mexican wind and quake across four tranches of catastrophe-linked Capital At Risk notes to be issued by the IBRD.

Now, the issuance is targeting from $410 million to as much as $525 million of disaster insurance protection from the capital markets, making this issuance the largest so far from Mexico and more than a replacement for the soon to mature $260 million 2018 issuance IBRD CAR 118-119.

The trustee of FONDEN will be the beneficiary of the insurance coverage from this catastrophe bond, entering into an insurance agreement with the Mexican government-owned insurer Agroasemex S.A. to secure it.

Agroasemex S.A. in turn enters into a reinsurance arrangement with global firm Swiss Re, who act as ceding reinsurance company, and Swiss Re in turn enters into retrocessional reinsurance agreements with the IBRD, the issuer of the notes.

Four tranches of catastrophe bond notes will be sold to secure the necessary collateral to underpin the retrocessional reinsurance, which then cascades down to the beneficiary.

Two tranches of earthquake-linked notes will be issued, as well as one tranche of notes covering Atlantic named storms and one covering Pacific named storms and all four tranches providing their disaster insurance coverage to the Mexican government on a parametric trigger and per-occurrence basis across a four-year term.

At launch the deal featured exactly $425 million of notes, but changes have occurred to match demand from investors, as we detail below.

The first tranche of Class A notes, a lower-risk earthquake exposed layer, launched targeting $125 million of protection for Mexico from notes having a modelled expected loss of 0.9% and price guidance of 3% to 3.5%. Now, we’re told, this tranche is targeting an upsized $150 million to $175 million of coverage, with price guidance now fixed at the top-end of guidance at 3.5%.

What was a $100 million tranche of Class B notes, a higher-risk earthquake exposed layer with a modelled expected loss of 5.78% and initial price guidance of 8.25% to 8.75%, is now targeting $60 million to $100 million and with tightened price guidance of 8.75% to 9%, so at the top-end or above of initial spread guidance, we understand.

What was a $100 million tranche of Class C notes, covering named storms and hurricanes on the Atlantic coast and with a modelled expected loss of 5.61% at the base case, had initial price guidance for investors of 10% to 10.5%. This tranche is now marketed as targeting $100 million to $125 million with price guidance tightened to 10% to 10.25%.

The final $100 million Class D tranche, covering named storms and hurricanes on the Pacific coast of Mexico with a modelled expected loss of 4.06% , were initially offered to investors with price guidance of 6.75% to 7.25%. This tranche is now also targeting $100 million to $125 million with price guidance tightened to 6.5% to 6.75%.

From the way the pricing has moved it looks like investors demanded more spread on the earthquake exposed layers of notes, perhaps a reflection of recent quake activity in the country, but also of losses paid historically for Mexico from its catastrophe bonds.

It’s encouraging that the addition of hybrid and sustainable bond features within this latest catastrophe bond from the World Bank has not deterred the investor base from showing interest, as evidenced by the chances of it upsizing.

As we explained previously, this latest catastrophe bond from the World Bank and IBRD has a twist to it, in that it is the first ever cat bond where the proceeds from the sale of the notes can be used by the IBRD to fund sustainable development projects in its member countries.

The hybrid structure, incorporating elements of a sustainable development bond alongside a catastrophe bond, is a concept that has been broadly discussed around the market as a mechanism for tapping into investor appetite to allocate to ESG appropriate assets.

It’s assumed this means the IBRD can use the liquidity from the sale of the notes within its developmental programs and projects, but if the catastrophe bond is triggered it will make up the collateral to the agreed amount under a guarantee.

In this way, it is a kind of sustainable development bond investment, as well as a catastrophe linked investment, at the same time, perhaps attracting an increased range of institutions and investors, broadening the insurance-linked securities (ILS) investor base.

Generali recently launched its own framework for Green Insurance Linked Securities which provides details on a similar way to make catastrophe bonds an even more ESG appropriate investment opportunity.

We’ll continue to update you as this new IBRD / FONDEN 2020 catastrophe bond progresses to market for the government of Mexico and you can read about this and every other cat bond transaction in the Artemis Deal Directory.

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