Commentaries

Cat bondage

Catastrophe bond lovers and other insurance-linked securities enthusiasts should take a look at a report on insurance securitisation published today by the International Association of Insurance Supervisors (IAIS).

There is an interesting section in the report looking at the various cat bonds that have gone pear-shaped since the dawn of the market in the 1990s.

The first bond in which investors suffered losses was Georgetown Re, sold by Goldman in 1996.  The report explores four other deals that have come under stress since then due to losses from natural disasters or other insured risks.

All in all, the track record is pretty good for most of the 300-odd deals sold. Unfortunately, the dogs start to mount up after the financial crisis broke in 2007.

Most of the more recent deals that ran into trouble did so not because of the insured risks, but as a result of the way the deals were put together, and bankers’ occasional fondness for using them as dumping grounds for dodgy assets.

First there are the four cat bonds in which Lehman acted as a derivative counterparty and which were collateralised in some cases by asset-backed debt. Investors were left out of pocket when Lehman failed and the bonds’ had to rely on the toxic debt to pay interest and principal.

Then there is Ballantyne Re, sold by Bermudan insurer Scottish Re. This deal was supposed to provide the insurer with regulatory capital, but the collateral it held as cover for that insurance turned out to be subprime and other mortgage assets. That left Scottish Re short of insurance cover and hurt investors. A similar situation developed with Orkney Re II.

Pain in Spain hits cat bonds

Defaults by catastrophe bonds, securities used by insurers to shift the risk of severe losses from natural disasters, have been few and far between.

When deals have run into trouble, it has often been due less hurricanes or earthquakes than some flaw in the way they were structured, such as the four bonds that imploded last year because of their links to Lehman Brothers and dodgy asset-backed debt.

Today Standard & Poor’s downgraded another deal in trouble, Swiss Re’s 252 million euro Crystal Credit transaction. Once again, the problem here is man-made.

This deal is different from most other cat bonds in that it doesn’t reference losses from natural disasters, but is instead tied to the performance of Swiss Re’s credit reinsurance business. Losses on the reinsurance contracts have started to climb as the economy soured. In particular, S&P says, the credit reinsurance business got hit by a “steep increase” in Spanish reinsurance claims.

It’s not the first time these bonds have been downgraded, although things seem to be getting worse. S&P says it’s “most likely” the class C bonds won’t make their principal payments in full at maturity. These were once rated B, and have now fallen to CC. The senior bonds, which were once investment grade, are now B+.