Guy Carpenter issued an update today on the Cat Bond market stating that the “influence from direct capital market participation in reinsurance programs, coupled with catastrophic insured losses well below historical averages in 2013, put significant pressure on global catastrophic reinsurance pricing”. They also made the point that “spreads have tightened between indemnity and other trigger types, sponsors were inclined to take advantage of investors’ openness to indemnity triggers to reduce coverage basis risk without a material increase in pricing relative to non-indemnity trigger pricing”.
The always interesting Global Property Catastrophe ROL index showed an 11% fall at January 2014.
I find it informative to compare current pricing to the past and the latest deal from Chubb covering US wind and quake risk from the NorthEast is hot off the press. East Lane Re VI increased in size to $270 million due to demand and got pricing at the bottom of the (already revised) pricing range at 275 bps. Thus the “20% more for 20% less” of the title of this post. The deal attaches in excess of $3 billion, above any historical storms (the largest of which is the 1938 New York storm at $2.9 billion), with a modelled 0.87% attachment and 0.77% exhaustion probability.
Although I am not sure if all of the conditions are exactly the same, it looks like Chubb got a good deal (for 4 years) compared to Class A of the East Lane IV Ltd, their expiring 2011 deal, which also covered US wind and quake risk in the NorthEast in excess of $3 billion. That one paid a 575 bps coupon, a whole 300 bps above the pricing they got this month!
Basically this is what we saw in other markets and continue to see… It’s deja vu all over again. Too much money searching for yield results in lower yields and weaker terms. As Buffet said: “Only when the tide goes out you see who has been swimming naked”.
Yep, we’ve all seen this movie before. To be fair 575bps does seem high for coverage that wouldn’t attach from any historical storm (based upon today’s exposure). The rule of thumb is the top layer shouldn’t be below 2% rate on line (that’s the market perception of the minimum risk premium for a decent ROE). However I don’t know the exact details here on Chubb’s cover. The drop from 575bps to 275bps is the point at issue. Sure, it’s all free money anyway…..
What I found interesting is the very thin “tranche” (in credit lingo), ie that 0.87% prob is the attachment point and 0.77% the exhaustion point. Is that common ? If not I would assume that the spread is relatively high because of the higher risk of total capital loss.
Depends where the layer is, the higher up the more likely it’s a s^^t or bust. Once the damage gets past a certain point buildings need to get totally written off (e.g. earthquake)
Lower down the difference between attachment & exhaustion is wider. A current deal on Artemis is Riverfront Re expected to price with a coupon of 4% and an attachment probability of 1.99% & exhaustion probability is 0.61%
Hope that helps.
Thanks, that helped indeed. I forgot that damages are not arbitrarily granular. As you said, once a building for example suffered sufficient damage it is written off. So the contract boils down to a coin flip: with 99% probability nothing happens and you pocket the premium. 1% of the time you loose the entire notional, ie a bimodal distribution.