5 August 2015ILS

Innovation that reaches further

Bermuda has emerged in recent years as the global hub for insurance-linked securities (ILS)—a tribute to its continuing willingness to embrace innovation in risk transfer. This also means that some of the most unusual and cutting-edge ILS transactions are issued from its shores.

One deal that certainly fell into this category was Compass Re II, a first of its kind catastrophe bond launched by American International Group (AIG). It was structured to provide just six months of coverage to the insurer during the official Atlantic hurricane season, from June 1 to November 30.

Such a short duration is unusual but it was also notable for other reasons. It uses a parametric trigger, the first time such a structure has been applied to a rated US wind bond for many years.

A parametric trigger would mean it would pay out quickly and in full if an event occurs. This is the first time this has been used on a US wind bond for at least five years, with issuers tending to prefer indemnity triggers in recent years. These take longer to calculate and thus a payout to occur but the payout is more likely to match exact losses.

The deal is structured on a per-occurrence basis using a parametric index trigger constructed using event parameters reported by the National Hurricane Center.

For AIG, this bond, using this trigger, would pay out quickly and give it almost instant capital if a big hurricane were to strike anywhere between the Gulf and the East coast of the US.

Noteholders are exposed to principal loss if the Event Index Value exceeds 100.0 and face total principal loss if the Event Index Value reaches 150.0.

"It is structured as a zero coupon bond, meaning investors receive their premium at its maturity rather than through quarterly coupon payments."

AIR Worldwide has modelled this cat bond and Fitch has provided its rating of B+ to the bond.

The deal is also interesting because it is structured as a zero coupon bond, meaning investors receive their premium at its maturity rather than through quarterly coupon payments. While this is common in the world of corporate and government bonds, it is unusual in the world of ILS.

Finally, it was also the first bond to be structured by Rewire Holdings and marketed using its new online marketplace.

Largely because of the short duration and the parametric trigger, it was viewed as something as an experiment when AIG first starting marketing it. To put this in context, other deals with unusual durations had previously struggled. At the other end of the spectrum, Allstate was forced to pull Sanders Re 2015-1, a $130 million cat bond designed to provide it with seven years of coverage.

But investors embraced AIG’s six-month deal. In the event, its size was increased during the marketing period to $300 million from $200 million on the back of strong investor demand.

Jeff Mohrenweiser, senior director at Fitch, which assigned a rating of B+ to the bond, says the structure of the deal, including the zero coupon, was obviously attractive to investors. “It is a clean, simple structure,” says Mohrenweiser.

He adds that he believes that AIG may have been attracted to working with Rewire because of its fresh approach to this sector.

“In a space dominated by a handful of large players, it is nice to see a new entrant doing something innovative,” Mohrenweiser says. “There is an element of creativity to this deal that some in the market are clearly looking for.”