U.S. military mutual insurer USAA is back in the catastrophe bond market again with a $150m Residential Reinsurance 2015 Ltd. (Series 2015-1). The deal looks set to test ILS investor pricing limits, as one tranche seeks to push a new low compared to the insurers previous deals.
This will be USAA’s 24th separate issuance of catastrophe bonds, since its first transaction way back in 1997. All 23 of the insurers previous deals are listed in our Catastrophe Bond Deal Directory.
USAA has been seen to push boundaries in cat bonds, being the first to include new unmodelled perils and also responsible for launching the highest risk tranche of notes ever seen. This Residential Re 2015-1 cat bond may push the boundaries further, in terms of price that investors will accept.
According to sources, USAA is seeking to secure a new source of fully-collateralized reinsurance from the capital markets. A newly Cayman Islands vehicle, Residential Reinsurance 2015 Limited will seek to sell two tranches of notes to ILS investors, to collateralized the underlying reinsurance agreements.
The reinsurance protection provided by the cat bond will cover USAA for certain losses suffered from tropical cyclones (and flood for rented property policies), earthquakes (and fire following), severe thunderstorms, winter storms, wildfires, volcanic eruption and meteorite impacts.
The protection afforded by the two tranches of notes will be on an indemnity trigger and annual aggregate basis, over a four-year term against losses suffered from the above perils across the U.S. and District of Columbia.
A Class 10 tranche of notes is being marketed with an initial size of $50m and will cover losses from an attachment point of $959m up to an exhaustion at $1.134 billion. That equates to an initial attachment probability of 8.33%, an exhaustion probability of 4.63% and an expected loss of 6.2% base, 7.28% sensitivity case.
A $100m tranche of Class 11 notes are less risky, covering losses from an attachment point of $1.134 billion up to an exhaustion point of $1.791 billion. That gives these notes an initial attachment probability of 4.63%, an exhaustion probability of 0.89% and an expected loss of 2.16% base, 2.5% sensitivity case.
So the Class 10 notes are significantly more risky than the Class 11, although not the most risky notes that USAA has ever sponsored in the cat bond market. If successfully issued, however, they might be the lowest priced on a risk adjusted basis.
The Class 10 notes are being offered with coupon price guidance of 10.75% to 11.75%. That would suggest a multiple of just 1.9x’s the base expected loss, or 1.6x the sensitivity case, even if it priced at the top end of guidance. That is a low multiple by any degree of analysis, especially for a riskier tranche.
The Class 11 tranche are being offered to investors with price guidance of 5.5% to 6%, suggesting a multiple of 2.8x’s the base expected loss, or 2.4x the sensitivity case, again taking the top end of price guidance.
Where this get’s interesting is if you compare the transactions to their nearest equivalent of the 51 other tranches of cat bond notes that USAA has sponsored since 1997.
The nearest comparison to the Class 10 notes are the Class 7 tranche from the Residential Reinsurance 2012 Ltd. (Series 2012-1) cat bond. The Series 2012-1 Class 7 tranche were the riskiest tranche of cat bond notes we’d seen and also the highest priced at their time of issue.
With an expected loss of 6.19% and providing the same annual aggregate protection, the Series 2012-1 Class 7 notes sit in almost the exact same attachment layer as the 2015-1 Class 10. However the 2012-1 Class 7 notes priced to pay investors a coupon of a massive 22%.
So at the price guidance offered for this 2015-1 cat bond, it looks like USAA could achieve a near halving of the interest spread paid to investors. While that seems steep it is roughly aligned with price declines seen over the last three years for other comparable cat bond tranches. However this is a particularly risky tranche of notes.
Meanwhile the Series 2015-1 Class 11 tranche sit alongside a Residential Reinsurance 2013 Ltd. (Series 2013-1) Class 11 tranche of notes. That tranche paid investors an 8% coupon, so the decline in pricing is not as steep as is being sought for the riskier layer.
The risk interest spread on offer may attract investors to the Class 11 tranche, very few cat bond offer a 10% plus coupon in recent months. As a small tranche, some investors will likely appreciate the opportunity to add a little additional return to their portfolios, however the riskier tranche is unlikely to fit with every ILS investors risk appetite.
This Residential Re 2015-1 cat bond is being brought to market by joint structuring agents and bookrunners Goldman Sachs and Swiss Re Capital Markets, while Deutsche Bank is also joint bookrunner. AIR Worldwide is providing risk modelling services.