The catastrophe bond most at risk of default from hurricane Isaac was the $125m Pelican Re Ltd. Pelican Re is an indemnity cat bond, providing cover to Louisiana Citizens, the property insurer of last resort for the state. The reason Pelican Re was felt to be most risky is that the indemnity trigger is set at a relatively low amount of losses. Both Louisiana Citizens and the Louisiana Insurance Commissioner have now said they don’t expect Isaac to have triggered Pelican Re, but the storm’s approach did have a marked effect on the deals pricing.
The trigger for Pelican Re is set at an ultimate net loss to Louisiana Citizens of just $200m and the exhaustion point is $400m. This means that Pelican Re could potentially be at risk even from a Category 1 storm, like hurricane Isaac, if Louisiana Citizens portfolio of property insurance was hit particularly hard. Because of the low trigger point the Pelican Re cat bond has a high probability of attachment at 4.74% and a high expected loss of 3.25%, high when compared to many other cat bonds anyway. So it is natural that investors will have felt that if they held Pelican Re notes it might be worth trying to sell them on the secondary cat bond market as hurricane Isaac approached.
One of the benefits that cat bonds and insurance-linked securities offer to investors is the existence of a secondary market where the notes can be bought and sold over the duration of the transactions lifetime. When an approaching hurricane triggers buying and selling of cat bonds it is often referred to as livecat trading, and this happened as hurricane Isaac neared the Louisiana coastline.
Swiss based ILS investment manager LGT Insurance-Linked Strategies had already announced that they expected no impact to their fund from hurricane Isaac, but now they have provided some interesting insight into how the market reacted to the possibility that the Pelican Re cat bond could be at risk.
The LGT ILS team said that prior to hurricane Isaac’s formation, the Pelican Re cat bond notes were priced solidly above par, around the 102.5 mark. However, as Isaac intensified and approached the U.S. coastline, the market saw the opportunity for livecat trading, and the bonds bid/ask spreads widened to what LGT called ‘interesting levels’.
When this happens some of the livecat trading can involve speculators, investors who might try to buy bonds at lower prices in the hope that they wouldn’t be hit by a catastrophe event, assuming that once seen to be safe the bonds value will recover thus providing them with a profit.
LGT noticed one particularly unusual pricing for Pelican Re where a traders offer showed a bid price of 93 and an ask price of 101 in the same communication. The spread between bid and ask here clearly shows the uncertainty in the market when a storm approaches or a catastrophe event threatens.
LGT said that by the 31st August, about two days after hurricane Isaac’s initial landfall, the Pelican Re cat bond notes were priced at 97.37, a full 4.2% down on a few days earlier. Conversely the notes of the Florida exposed Everglades Re Ltd. cat bond, which wasn’t directly exposed to Isaac, had gained more than 2% over the month of August.
LGT said that this pricing, particularly the increase in value of the Everglades Re notes, demonstrates the ‘exceptional environment’ which currently exists in the ILS and cat bond market, and the extraordinary demand for the asset class even during the peak of the hurricane season. LGT expects prices in the market will tighten further as we move through the remainder of the hurricane season, which will have a positive impact on the performance of their fund over the next few months.