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Original Risk: A Society for Change Agents

Pelican Re 2013 cat bond features novel on-request drop-down


In our discussions with market participants this week we’ve managed to glean a few more details about the recently launched second catastrophe bond from Louisiana Citizens Property Insurance Corporation, the coastal windstorm insurer of last resort. The Pelican Re Ltd. Series 2013-1 cat bond launched late last week and sees the insurer looking to tap the capital markets a second time for cat bond cover to the tune of at least $100m.

As we said in our article on the deals launch last week, we suspected that a cat bond may be forthcoming from Louisiana Citizens given that their CFO Steve Cottrell had recently said that if the price was right the insurer would consider tapping the cat bond market again as part of its 2013 reinsurance renewal. Based on evidence from recent cat bond transaction pricing and the discussions of a soft ILS market it’s no surprise to see the insurer bring this second deal to market.

So here is the expanded information we now have for the Pelican Re 2013-1 cat bond, including some details of what appears a novel drop-down feature in the structure which makes the coverage more flexible for the sponsor. While we can’t be sure how novel this drop-down actually is, it’s not a feature we hear of in most cat bonds we cover. It makes a lot of sense from a sponsors perspective and could be a feature we see more of if this deal gains investor acceptance (we see no reason why it shouldn’t).

Pelican Re Ltd. will seek to issue at least $100m of notes to provide Louisiana Citizens with a new source of capital market backed fully collateralized reinsurance cover. The sale of the notes will collateralize the reinsurance agreement between Pelican Re and LA Citizens, with the reinsurance providing protection from hurricane losses on a per-occurrence basis and using an indemnity UNL trigger.

The hurricane coverage from this cat bond will protect LA Citizens from losses within its Coastal and Fair plan books of business. These include the most at risk hurricane locations, coastal and otherwise, within Louisiana state. Both the Coastal and Fair plans contain residential and commercial properties, although we understand that the covered business is predominantly residential in nature.

The transaction will use an initial attachment point of $389m of ultimate net loss to the covered business and an initial exhaustion point of $539m we understand. That equates to an initial attachment probability of 2.29% and an initial expected loss of 1.88%. The deal is being marketed with a coupon or interest spread range of 7% to 7.5%.

The word initial in the attachment is important here, in fact more important than in many other cat bond transactions, as the structure of Pelican Re 2013-1 will allow the sponsor to adjust the reinsurance layer that the deal provides by opting to reset the attachment point. This is effectively a drop down facility, the coverage can be dropped down the reinsurance tower, but at the sponsors request rather than after a triggering event or loss. This allows the sponsor to move the coverage of this cat bond up and down its reinsurance program tower, adjusting the important factors of attachment, exhaustion and as a result the coupon interest paid to investors.

This is actually a very useful structure which will allow Louisiana Citizens to ensure that this cat bond provides cover where it most needs it within its whole reinsurance program. It will also allow the insurer to react to other market dynamics, such as traditional reinsurance for the layer beneath the cat bond becoming very expensive, in which case it could drop the cat bond coverage down to replace it. It would also allow the insurer to drop-down the 2013 cat bond to replace the 2012 cat bond when it matures in April 2015, the 2013 deal being four years doesn’t mature until 2017. That is especially smart as if cat bond cover suddenly became very expensive it may well be significantly cheaper to drop-down this new layer instead of issuing another bond.

Louisiana Citizens will be able to request an ‘optional reset’ at any time after the first risk period is over we’re told which will enable it to lower the attachment point, thus increasing the probability of attachment and expected loss of the notes and also increasing the coupon paid to investors. We’ve seen similar drop-down features which come into effect after some losses are suffered, but we understand that this drop-down can be requested which makes it a little different, and in our eyes a sensible addition to a cat bond for a sponsor like LA Citizens.

The coverage layer can only be moved within pre-defined limits and the transaction has a maximum attachment probability figure of 4.73% which we understand would be at $193m according to the modelling, a maximum expected loss of 3.26% and we’re told also a maximum possible coupon price range of 10% to 10.75%. This restricts the level that these factors can change and gives investors some certainty about the level of interest spread they would receive in return for heightened risk should the sponsor opt to lower the attachment point at some point after the first risk period.

Aon Benfield Securities are acting as structuring agent and bookrunner for this cat bond and AIR Worldwide are providing the risk modelling services. AIR Worldwide has modelled a number of historical events against this deal and we understand that three hurricanes were shown to cause a 100% loss to the notes no matter where the layers attachment was set at the time, including Katrina from 2005.

That’s all we’ve managed to glean from our sources on this deal so far. It will be interesting to see how investors take to the transaction, it’s an interesting opportunity for them as it offers some diversity, being Louisiana hurricane only, and the option drop-down facility adds another interesting factor.

For now we’ve added these details to our Deal Directory in a new entry for Pelican Re Ltd. (Series 2013-1). We’ll update you as we hear more about this transaction as it comes to market.

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