Reinsurer Swiss Re has begun marketing their latest insurance-linked security transaction and this time it’s a deal that the wider ILS investment market should appreciate as it’s a diversifying opportunity and a life transaction. Swiss Re are bringing their latest Vita Capital mortality-linked catastrophe bond to market, their fifth such transaction, being issued through a Cayman Islands entity Vita Capital V Ltd. which will issue two tranches of mortality-linked notes.
Swiss Re’s Vita Capital deals have become one of the regular life ILS transactions to come to market each year and investors generally show high demand for them as they offer a good diversification for investment portfolios. There are also a number of investment managers who commit to keeping their ILS funds exposed to life risks to some degree and so this fifth Vita Capital deal should be well received.
In this Series 2012-1 issuance, Vita Capital V Ltd. will seek to issue two tranches of mortality-linked cat bond notes. The aim of the transaction for Swiss Re, is to secure a fully-collateralized source of multi-year extreme mortality protection via risk transfer to the capital markets.
The notes issued by Vita Capital V will provide Swiss Re with cover via an ISDA-based contract and protection is afforded on an aggregate basis over a five-year risk period against excess mortality in certain specified countries. The Class D-1 tranche of notes covers excess mortality in Australia and Canada while the Class E-1 notes cover excess mortality in Australia, Canada and the U.S. Both tranches are being marketed as at least $50m in size we are told by sources, but it’s likely that Vita Capital V will be larger than $100m by close if Swiss Re choose to take advantage of inevitable demand for mortality risk in this form. For each class of notes, Swiss Re and Vita Capital V have entered into an ISDA-based counterparty contract under which the counterparty (which is Swiss Re) will make payments in exchange for extreme mortality protection (provided by Vita Capital V) for a specified notional amount.
Investors in the notes issued by Vita Capital V will be at risk of an increase in age and gender weighted mortality rates that exceed a specified percentage of a predefined mortality index value for the term of the deal. Interestingly, the five-year risk-period is slightly retrospective and the first risk period began on the 1st January 2012, meaning that mortality data from the first half of this year is included in the deals calculation. However the way the deal triggers means that makes sense.
The trigger is based on a mortality index and there are predefined points on the index where the notes can be triggered and hence suffer a loss of principal. For the Class D-1 notes to be triggered and any loss of principal to occur, the Australia reference mortality index would need to increase by at least 35% or the Canada reference mortality index would need to increase by at least 20% over any two consecutive-year measurement period between 1st January 2012, and 31st December 2016. For the Class E-1 tranche of notes, one of the reference mortality indices would have to increase by at least 20% for Australia, 10% for Canada, and 5% for the U.S. over the same measurement period. The mortality index value (MIV) is defined on a rolling two-year period and so the likelihood of a loss occurring or the amount of any loss depends on the extent to which the mortality index value exceeds the attachment point for the notes.
Risk Management Solutions (RMS) are providing risk modelling and also calculation agent services for this transaction and as with any mortality transaction it involves very complex modeling using a variety of sources including longevity, infectious disease, earthquake, wars, terrorism and statistical modelled peril models.
Mortality catastrophe bonds such as Vita Capital V are exposed to large increases in mortality rates and so events such as pandemics, influenza outbreaks, tsunamis, earthquakes, major natural catastrophe events, terrorist attacks, disease epidemics or an unmodeled event could impact the deal. However these are remote risks and as such transactions such as this generally have lower probability of attachments than many natural catastrophe bonds.
Collateral from the sale of the notes will be invested in International Bank for Reconstruction and Development (IBRD) notes. Interestingly this is the first deal where the collateral investment will pay a negative percentage below LIBOR back as we’re told that the IBRD notes will pay around 0.3% below LIBOR. That is due to the historically low-interest rates in the wider financial markets caused by the economic crisis that is hitting certain regions and markets hard.
Standard & Poor’s have given the two tranches of notes preliminary ratings and also comment on the probability of this deal being triggered. S&P considers that an event such as another pandemic similar to the 1918 flu outbreak, a large event risk such as a full-scale ground war or tsunami, or several nuclear bombs exploding in large cities in Australia, Canada, or the U.S. could cause a loss for the noteholders. RMS’ risk analysis also concluded that a recurrence of the 1918 flu pandemic and World War I would have resulted in a 100% principal reduction to the Class E-1 tranche of notes, but only the 1918 flu pandemic would have resulted in a 100% principal reduction to the Class D-1 notes. In the past 100 years, events such as the peak of AIDS deaths in 1987 and the terrorist attacks of Sept. 11, 2001, would not have triggered any loss of principal under the terms of the notes. In S&P’s view, the biggest risks are a man-made catastrophe, such as a nuclear, chemical, or biological war/terrorist attack; a natural catastrophe; or a substantial pandemic. S&P has given the Class D-1 notes a preliminary rating of ‘BBB-‘ and the Class E-1 notes a preliminary rating of ‘BB+’.
These mortality catastrophe bond notes are not seen as particularly risky in the spectrum of ILS and cat bonds and the probability of attachment is relatively low when compared to other ILS deals. Hence they are expected to pay a relatively low-interest coupon to investors. We’re told by sources that the Class D-1 notes have an attachment probability of 0.34% and will likely pay a coupon in the range of 2.7% to 3%, while the Class E-1 notes have an attachment probability of 0.8% and will likely pay a coupon in the region of 3.4% to 3.8%.