Swiss Re Insurance-Linked Fund Management

Xactanalysis Insights and PCS

Zurich returns to catastrophe bond market with Lakeside Re III Ltd.


Insurance group Zurich is returning to the catastrophe bond market with the third deal in the Lakeside cat bond series. Lakeside Re III Ltd. see’s Zurich looking to replace and also expand the cover that their last cat bond Lakeside Re II, which matures at the end of 2012, provided. Once completed Lakeside Re III will provide Zurich American Insurance & Zurich Insurance Co. Ltd. and certain pool companies with a three-year source of earthquake reinsurance in the U.S. and Canada.

Previous Lakeside Re deals only covered earthquakes in California but Lakeside Re III broadens the scope of the cat bond to provide reinsurance cover for earthquakes in the Canadian provinces of Alberta, British Columbia, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island and Quebec as well as the U.S. states of California, Michigan, Ohio, Wisconsin, Arkansas, Illinois, Indiana, Kentucky, Louisiana, Mississippi, Missouri, Tennessee, Oregon and Washington. The U.S. states covered means that Zurich is including its New Madrid fault risks in this deal along with Californian and Pacific Northwest quake risks.

As well as straightforward earthquake cover this cat bond also covers various types of damage which could ensue from an earthquake or ground-shaking, including fire following, sprinkler leakage, volcanic disturbance or eruption, tsunami and flooding caused by dam or levee breaches.

The Lakeside Re III cat bond utilises an indemnity (ultimate net loss) trigger and provides cover on an annual aggregate basis over the three-year risk period. Under the terms of the underlying reinsurance contract Zurich maintains a retained share of at least 10% of the aggregated ultimate net losses for each annual risk period.

For an earthquake to become a covered event it must meet certain parameters we understand. It must be reported by the USGS and it must cause ground-shaking in the covered area of intensity level VI or more (a measurement from the USGS Shakemap). Also for an event to qualify under the terms of the reinsurance contract the ultimate net loss to Zurich must be at least $35m, the franchise deductible level. If the deal completes at $225m the notes will cover 75% of losses from the attachment point of $650m up to the exhaustion point of $950m, with Zurich required to retain at least 10% of losses. The covered business is largely commercial but may include some personal risk.

California contributes 62.9% of the expected loss of the cat bond, New Madrid is 12.6%, Pacific Northwest is 8.6%, Eastern Canada 4.8% and Western Canada 11.3%. Los Angeles and Vancouver contain the highest exposure by city.

The attachment probability for the notes is 2.9%, the expected loss is 2.09% and the exhaustion probability is 1.49%. The notes will be reset annually based on the latest exposure data provided by the sponsor.

Based on remodelling of historical events by risk modeller RMS no historical events since 1906 would have reached the attachment point for this deal. Five years between 1663 and 1906 would have seen the cat bond attach and some principal reduction occur. 1732 (Montreal/19% principal reduction), 1811 (New Madrid/100% principal reduction), 1812 (two events in the New Madrid region/100% principal reduction), 1868 (Hayward/68% principal reduction) and 1906 (San Francisco/100% principal reduction) are years that saw events that caused principal reductions.

Collateral is being dealt with using collateral account but the deposits will be initially invested in the MEAG Lakeside Re III fund which has been established for this cat bond by Munich Re’s investment subsidiary. This is the same collateral strategy as used by Munich Re’s Queen Street cat bonds.

Lakeside Re III is a Bermuda domiciled special purpose insurer established for issuing catastrophe bond notes for this transaction. The single tranche of notes being issued by Lakeside Re III have received a preliminary rating from Standard & Poor’s of ‘B+’.

We’re told that the guidance range for pricing for this Lakeside Re III cat bond is 8.0% to 9.0%.

This cat bond offers investors a level of diversification, particularly as New Madrid and Canadian quake risks are not so common in the cat bond market. We expect this deal to be popular with investors and there is a chance Zurich may choose to increase the size of the deal. Their previous Lakeside Re deals, Lakeside Re II Ltd. and Lakeside Re Ltd. were both California quake only and sized at $225m and $190m respectively. Given the much larger coverage area this deal could upsize.

Details have been added to our catastrophe bond Deal Directory and we’ll update you as Lakeside Re III comes to market.

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