Swiss Re Insurance-Linked Fund Management

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USAA returns with $150m Residential Reinsurance 2016 cat bond


U.S. military mutual insurer USAA is returning to the capital markets for its latest, and 27th securitization of insurance risk, with a $150m, three tranche, Residential Reinsurance 2016 Limited (Series 2016-1) catastrophe bond.

USAA remains the most prolific sponsor of cat bonds in the market’s history, with the insurer now having sponsored 26 deals, its latest being the efficiently issued Espada Reinsurance Limited (Series 2016-1) transaction, and having over $1.6 billion of cat bonds currently outstanding providing it with fully collateralized reinsurance coverage.

Sources familiar with the transaction said that this 2016-1 cat bond sees USAA looking for another expansion to the terms of its ILS investor backed reinsurance coverage, with the peril description extended to include a category of “others”.

The “other perils” category will enable USAA to use its coverage from this Residential Re 2016 cat bond for losses from any natural disaster or severe weather event which is classified as a catastrophe by reporting agency PCS, aside from the named perils or flood.

Despite the flood exception, USAA has included flood coverage for renters policies under the tropical storm and hurricane event definition, for what we believe to be the first time, so there is an element of flood risk in this new cat bond.

This transaction will see newly registered Cayman Islands registered Residential Reinsurance 2016 Limited issuing three tranches of Series 2016-1 notes, with each tranche having a preliminary size of $50m.

All three tranches will be exposed to tropical cyclone risks, including renter policy flood cover, earthquake (including fire following), severe thunderstorm, wildfire, winter storm, volcanic eruption, meteorite impact and the “other perils” across the U.S.

All three tranches will feature an indemnity trigger and provide USAA with reinsurance protection on an annual aggregate basis, we understand. The notes will have a four-year term.

A $50m Class 10 tranche of notes are set to be the riskiest, attaching at $910m and covering a percentage of USAA’s losses up to $1.202 billion. These notes have an initial attachment probability of 12.03% and an expected loss of 7.58%. The coupon spread for this tranche is marketed as a range of 11.75% to 12.75%.

Next, a $50m Class 11 tranche of notes would attach at $1.202 billion of losses and exhaust at $1.918 billion, resulting in an attachment probability of 4.61% and an expected loss of 2.13%. This tranche is being offered to investors with price guidance of 5.25% to 6%.

Finally, a $50m Class 13 tranche has an attachment point at $1.918 billion, covering losses to an exhaustion point at $2.638 billion. This tranche has an attachment probability of 0.98% and an expected loss of 0.62% and offer investors a coupon in the range of 3.75% to 4.25%.

So this Residential Re 2016-1 cat bond offers ILS investors a range of risk and return options, from the much more risky Class 10 notes, which have a base multiple of 1.6 times expected loss at the mid-point of guidance. To the mid-risk Class 11, which have a multiple of 2.6 times at the mid-point of guidance. Or the much lower risk, but perhaps higher return per unit of risk, Class 13 notes which have a much higher multiple of 6.5 times expected loss at the mid-point of coupon guidance.

With the selection of risk and return levels, as well as the broad layers that each tranche will cover, USAA has plenty of scope to increase the size of this cat bond, if it should choose to hand over more of its reinsurance program to the capital markets and ILS investors.

The attachment point is comparable with some existing USAA cat bonds, allowing us to compare the potential pricing to a degree and giving another snapshot of how cat bond pricing has declined in-line with the overall reinsurance market.

The 2016-1 Class 10 notes attach at the same level as USAA’s Residential Re 2014-1 Class 10 notes, which paid investors a coupon of 15%.

The 2016-1 Class 11 notes attach at the same level as the Residential Re 2013-1 and 2015-1 Class 11 notes, which paid investors coupons of 8% and 6% respectively.

Finally the 2016-1 Class 13 notes attach at the same level as the Residential Re 2014-1 Class 13 notes, which paid investors a coupon of 3.5%.

So again, it’s clear that pricing will be more attractive than the similar deals for the two riskier tranches, for the Class 10 and 11 notes. Of course it’s important to note the expansion of the covered perils, suggesting even greater value for USAA from this its latest cat bond deal.

However, the lowest risk Class 13 notes in this Residential Re 2016-1 cat bond issuance could actually end up paying a higher coupon than the 2014-1 deal, reflecting investors demand for minimum returns on bonds with lower yields.

It’s also clear from the price guidance that investor demand for higher cat bond returns is encouraging much lower coupons, on such higher risk tranches as the Class 10 notes. At some point, however, even notes at this risk level need to find a floor in pricing, to ensure undue amounts of risk are not being assumed just to access the higher coupon tranches.

Goldman Sachs and Swiss Re Capital Markets, acting as joint structuring agents and bookrunners, are bringing the transaction to market, as well as Citigroup who are a joint bookrunner. AIR Worldwide is risk modeling agent.

We’re told that this Residential Reinsurance 2016 Ltd. (Series 2016-1) catastrophe bond is targeting pricing before the end of April and completion in early May.

It’s good to see USAA keeping the Residential Re series of cat bonds alive. After its recent Espada Reinsurance Limited (Series 2016-1) transaction there was a chance that it could have elected to use that vehicle for future issues, but clearly the insurer is keen to maintain its long-running cat bond naming convention for its residential insurance book.

We will keep you updated as the transaction comes to market and you can read all about this and every other catastrophe bond in the Artemis Deal Directory.

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