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Irene's Flooding Doesn't Move Cat Bond Market: Willis Exec

Source: A.M. Best

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Posted on 02 Sep 2011

Even as Hurricane Irene headed towards the East Coast, the catastrophe bond market didn't blink. But another significant storm could trigger some cat bonds, a Willis executive noted.

Secondary trading of existing cat bonds remained strong, as buyers and sellers traded in and out of the market, said William Dubinsky, managing director and head of insurance linked securities for Willis Capital Markets & Advisory.

"It's something positive that came out of a big hurricane," Dubinsky said. "There was considerable liquidity in the market. Going back to Hurricane Katrina or 2004, you would not have seen investors as easily move in and out of position."

That liquidity is a sign the cat bond market has matured, he said.

Dubinksy said he didn't expect any cat bonds to be triggered by Irene damage. The market doesn't cover the personal lines flood insurance line, which is primarily absorbed by the National Flood Insurance Program and expected to bear the brunt of Irene claims, Dubinsky said.

Of the $10.54 billion in existing cat bonds exposed to natural catastrophe, about $7.15 billion, or 68%, are exposed to U.S. windstorm risk, according to Willis Capital Markets.

That includes $507 million exposed exclusively to North Carolina hurricane risk from the Johnston Re cat bond, and $1.07 billion exposed exclusively to Northeast hurricane risk via Longpoint Re II, Shore Re and East Lane Re IV, according to Willis Capital Markets & Advisory.

Some cat bonds can be triggered by an aggregation of a number of small or medium events, so even if Irene didn't trigger the bonds, they may be closer to being triggered if another storm causes significant damage, he said.

Montana Re, a two-event bond, had one tranch that was impacted by the Japan earthquake in March, but it "seems unlikely that Irene is a big enough second event to trigger a loss," Dubinsky said.

Normally, the third quarter is a quiet time for new U.S. wind cat bonds to come to market. "The cat season is in session right now. You can't have more cat bonds issued now because those cat bonds would be at risk already," Emmanuel Modu, managing director and global head of insurance-linked securities at A.M. Best Co., said during an interview on Bloomberg Television's "Fast Forward with Lisa Murphy."

The fourth quarter is normally a busy time as companies work to replace cat bonds that have matured. This year, it's expected to be quieter than usual because no cat bonds came to the market three years ago, during the 2008 financial crisis, so there are no bonds automatically maturing this year, Dubinsky said.

Cat bond issuance was on the upswing in 2010, reaching $4.28 billion after a trough of $2.78 billion in 2008, according to A.M. Best Co.

In 2011, a new catastrophe model from Risk Management Solutions Inc., RiskLink Version 11.0, has been affecting both existing and new catastrophe bonds. For U.S. hurricane risks, RMS 11 led to the revision of attachment and exhaustion probabilities, and expected loss percentages, of 32 tranches of existing catastrophe bonds.

The second quarter of 2011 was relatively quiet for new cat bonds, with four issues totaling $592 million in risk capital, compared with eight transactions and $2.1 billion of risk capital in the second quarter of 2010, A.M. Best Co. said in a Sept. 5, 2011 global reinsurance special report.

"A.M. Best believes this recent slowdown may in part reflect uncertainty over the interpretation of RMS 11 output and its future impact on cat bond pricing," A.M. Best said.

All but three of the 32 tranches impacted by RMS 11 showed higher expected losses, and A.M. Best has downgraded the ratings on some of these cat bonds.

In July, A.M. Best downgraded the debt ratings to b from bb- on $100 million series 2009-1 Class A and to ccc from b on $75 million series 2009-1 Class B principal-at-risk variable rate notes issued by Montana Re Ltd. The rating actions were in response to A.M. Best's receipt of new attachment probabilities using the new model. The updated attachment probabilities showed a significant increase when compared to those previously calculated with the archived model, which was used in the initial modeling, A.M. Best said.

The Montana Re notes provide Flagstone Reassurance Suisse S.A. with $100 million protection against U.S. hurricanes (Class A) and $75 million protection against U.S. hurricanes and earthquakes (Class B). The protections are based on a modified property claim services index trigger on a per occurrence basis covering a three-year period that runs from Nov. 30, 2009 to Nov. 30, 2012.

Munich Re's$300 million Muteki cat bond transaction was a total loss due to the Japan quake, A.M. Best said.


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