Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Residential Reinsurance catastrophe bonds unaffected by covered events so far


Two classes of catastrophe bond notes issued by Residential Reinsurance 2008 Ltd. and Residential Reinsurance 2009 Ltd. have been accumulating aggregate losses over the past year including some from recent severe thunderstorm events in the U.S. The Residential Re cat bonds were issued by USAA to provide them with cover for a range of perils they are exposed to.

Standard & Poor’s have issued a ratings commentary on the two classes of notes; Residential Reinsurance 2008 Ltd. $100m Class 4 Series 2008-1 rated ‘BB+’ and Residential Reinsurance 2009 Ltd.’s $120m Class 4 Series 2009-1 rated ‘BB-‘. The ratings are not affected by any of the covered events which have occurred during the current risk period according to S&P, but the accumulating losses have got to a level where they felt it necessary to comment.

Both of these series of cat bond notes cover losses from certain severe thunderstorm, hurricane, earthquake, winter storm, and wildfire events on an annual aggregate basis. The Residential Re 2008 transaction was the first of USAA’s catastrophe bonds to cover severe thunderstorm, winter storm and wildfire.

Both Class 4 tranches of notes work on an annual aggregate indemnity basis, so qualifying events mount up over a years risk period but have to breach a set trigger level before any loss of principal is experienced by investors.

The current risk period began on 1st June 2010 and runs until 31st May 2011. There have been six covered events which have qualified under the terms of the cat bond transactions for which PCS have issued loss estimates; PCS catastrophe serial numbers 18, 31, 42, 43, 44, and 46. Total accumulated losses from these events are around $563m for the Series 2008-1 notes and $555m for the Series 2009-1 notes. The Series 2008-1 tranche triggers when accumulated losses exceed $1.754 billion and the Series 2009-1 tranche triggers when losses exceed $1.378 billion.

Given that there is now less than a month left to run in the current risk period, the 2008 deal matures at the end of May while the 2009 deal has another year to run but will reset the losses and attachment levels, it seems unlikely that any loss of principal will be incurred by investors. However, for S&P to issue such comments there must be some nervousness regarding these notes, potentially brought on by the recent severe thunderstorm losses. S&P point out that the primary peril likely to contribute to losses for both series of notes was expected to be hurricanes, but as U.S. hurricane season doesn’t start until June it is unlikely that any hurricane impact would be felt. If the recent severe thunderstorm and tornadic weather continues or any other covered losses occur, say S&P, then they may have to revisit the ratings and could potentially lower them.

It would be extremely unlucky at this late stage in the current risk period, and would require a really severe outbreak of weather which caused massive industry losses, for these cat bonds to experience any losses to these notes. That said, the recent severe weather in the U.S. has caused anywhere up to $5 billion in losses so it is worth keeping an eye on events throughout the rest of May.

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