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Cat Bond Holders Nervous Over Potential Losses from Japan's Earthquake

Source: WSJ - Katy Burne

Posted on 14 Mar 2011

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Japan's massive earthquake may affect about $1.5 billion of specialized securities called natural catastrophe bonds, leaving investors scurrying to determine their potential losses.

Reinsurers use the securities, known as "cat bonds," to transfer risk from their own portfolios into the capital markets. In exchange for regular payments over the life of the bond, investors risk losing part or all of their initial investment if a specified natural disaster occurs.

"I don't think anyone knows the potential loss yet," said one investor, noting it would be days before loss estimates filter through. "Nothing's trading."

At least eight cat bonds have exposure to the Japanese earthquake, said the investor, who agreed to speak about the market only if he was not identified. All eight were privately placed in the so-called Rule 144 market, meaning they could only be purchased by certain qualified investors and weren't available to the general public.

About $12.1 billion of nonlife catastrophe bonds are outstanding globally, according to estimates from Swiss Reinsurance Co., commonly known as Swiss Re, making the potential securities affected roughly 12.5% of the existing market.

Some of the bonds affected by the Japanese quake provided coverage for multiple perils in several regions, but all may be triggered by the earthquake's magnitude, rather than estimates of monetary losses. The investor said that was because of a lack of reliable catastrophe-reporting systems in Japan.

"This earthquake is a concern to the cat-bond market because of the high ground motions and damage extending to Tokyo," said Tom Larsen, product architect at risk modeller Eqecat Inc. "Some deals are all formulaic and meant to protect against a severe hit in one area, which this was not. Others are meant to cover a less-severe hit in a broader area, and that is what we have [Friday]."

Three of the world's biggest reinsurers—Swiss Re; Muenchener Rueckversicherungs AG, commonly called Munich Re; and Scor SE—are among those to have used cat bonds to reduce their exposure to Japanese earthquakes, though they highly diversified risks.

Swiss Re achieved protection through a $150 million bond sold in June 2008 and a $106.5 million bond in December 2010, both under its Vega Capital Ltd. program; and a further $120 million of protection through its Successor X Ltd. series 2010 program in March 2010.

Munich Re transferred $260 million of risk in October 2007 through a bond called Midori, after reinsuring the East Japan Railway Company for earthquakes in the Greater Tokyo area. It got another $300 million of coverage through a bond called Muteki after reinsuring Zenkyoren, a Japanese agricultural cooperatives insurer, in May 2008. Midori was unlikely to have been affected by Friday's events, according to the investor.

Scor placed Atlas VI in December 2009, obtaining €75 million ($103.7 million) of coverage against Japanese quakes.

Smaller reinsurers based in Bermuda also may be compensated, thanks to cat bonds they issued. Flagstone Reinsurance Holdings SA placed two series of bonds under its Valais Re program for a combined $104 million in June 2008; and $60 million under its Montana Re program in November 2009.

Rival Platinum Underwriters Bermuda Ltd. obtained $200 million of coverage through a bond called Topiary in August 2008.

Representatives for Munich Re and Swiss Re declined to comment on potential losses. A representative from Scor, Flagstone and Platinum didn't return requests for comment.