Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Vita Capital IV Ltd. Series III mortality notes downgraded on tsunami risk exposure


Swiss Re’s Vita Capital IV Ltd. mortality risk insurance-linked securities have had their rating downgraded by Standard & Poor’s due to the perceived heightened exposure that tsunami’s present to the transaction. Vita Capital IV Ltd’s Series III is an insurance-linked securitization which is exposed to increases in mortality in the U.S. and Japan over a three year period.

The Vita Capital notes were placed on CreditWatch negative by S&P in March as a result of the earthquake and tsunami in Japan. The number of fatalities in Japan is not expected to trigger the transaction alone, as the final toll was not high enough, but S&P say that the event highlighted the potential fatalities that tsunamis can cause and as a result that raises the risk profile for this transaction.

The noteholders of Vita Capital IV are at risk from an increase in age and gender weighted mortality rates which exceed a predefined percentage on a predefined index. For the disaster in Japan to have caused a default and loss of principal to noteholders, the indices would have to have increased by at least 7.5% over any two  consecutive-year measurement periods between October 1st, 2010, and September 30th, 2014. At the time of issuance of this deal Risk Management Solutions, who provided risk modelling services for the transaction, estimated that an event in Japan which caused 50,000 deaths and was evenly spread across all age and gender groups would cause a loss to the notes.

S&P note that RMS model the effect of earthquakes on the mortality of the population but do not do the same for tsunamis (which remain largely unmodelled). The high number of fatalities from the event in Japan which were attributable to the tsunami rather than the earthquake has highlighted the potential for further tsunamis to caused large loss of life and potentially impact the notes. Given the high level of fatalities from the 11th March tsunami noteholders are at a higher risk for losses anyway for the remainder of the current two year period.

S&P say that based on currently available information it is difficult to precisely quantify the impact of the number of fatalities from the March event on the attachment probability of the notes.

S&P conclude by saying that even if there are no further events which cause fatalities in Japan during the remainder of the risk period, they are unlikely to alter the rating on the notes again due to the unknown factor of unmodelled tsunami risk.

The Class E notes of Vita Capital IV have been downgraded from ‘BB+’ to ‘BB’ and removed from CreditWatch.

It seems a sensible move by S&P to take into account a largely unmodelled risk when considering the rating on these notes. The events in Japan have demonstrated just how severe the impact of a large tsunami can be on Japan and as a result this precautionary downgrade seems the right step to take. Having discussed Vita Capital IV with investors after the event in Japan we don’t believe that this will change their perspective of the transactions risk as the investors we spoke with were fully aware of the unknown factor of tsunami risks in Japan.

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