Swiss Re's recent US$100 million catastrophe bond issue, which protects the reinsurer from natural catastrophes in Australia, has received a mixed response from capital markets investors, some observers believe. This is because of the type of risk it covers and the resulting price.
The bonds, the first ever to cover Australian risks, were issued by special-purpose vehicle Australis. This initial issue provides Swiss Re with US$100 million of protection against earthquakes for the entire country, and tropical cyclones in the state of Queensland. The coverage period is three years. The deal has a parametric trigger. It pays out if certain characteristics of covered events, such as windspeed or earthquake magnitude, reach predetermined levels.
The initial issue is part of a US$250 million shelf program, which means Swiss Re can issue a further US$150 million of bonds from Australis if required. In this respect, Australis has a similar structure to Swiss Re's Arbor and Pioneer shelf cat bond program.
The notes issued in the first stage were underwritten by Swiss Re Capital Markets, and were rated double-B by Standard & Poor's. They priced at 400 basis points over three-month Libor.
Catastrophe bonds have traditionally been used to cover the most dangerous risks, such as windstorms in Florida or earthquakes in California. Because of the risks involved, these bonds usually pay high returns to investors. Australian earthquakes and windstorms are not in the same league as these risks, and so bonds covering them would generate lower returns – potentially making them less attractive to certain investors.
On the other hand, some investors would like such bonds because they allow them to diversify their portfolios away from the risks usually covered by cat bonds.
"With this type of deal you are always going to have differing investor opinions," says one investor, who asked not to be named. "In terms of price multiples it's a fringe-type bond. It's not the meat of what a cat bond is."
He explains that investors work in different ways. Some have to adhere to investment criteria that prevent them from buying bonds that pay less than a certain amount. Others, however, are willing to accept anything that offers them diversification. "The people that say this is not a good deal have restrictions to live with," says the investor.
The investor adds that he was one of those that liked the deal. "Personally, I think the pricing was very good on this," he says. "It's a fantastic bond. It is well-structured, with a parametric trigger."
The mixed investor response did little to hurt the bond's success. According to the anonymous investor, Swiss Re had initially planned to issue US$75 million-worth of bonds from the programme, but after receiving orders for US$150 million-worth, decided to increase the issue size to US$100 million. "It was well-received and was a successful deal in that way," he says. "It is a large enough market that if some don't like it, some are warmer towards it and others really like it, it can still be a success."
Swiss Re set up Australis so it could write more business in the Australian market without exposing Australian cedants to more of Swiss Re's credit risk. Many cedants are wary of buying too much reinsurance from one provider, because they could lose a big chunk of their protection if that one reinsurer went bust.
Catastrophe bonds pass the risk on to the capital markets, and are fully collateralized, removing the credit risk.
"By securitizing natural catastrophe risk into the capital markets, Swiss Re is not only able to back up existing capacity, but also to create additional underwriting capacity with no credit risk," says a Swiss Re spokeswoman. "Swiss Re has achieved a very strong market position in Australia and has been able to increase its capacity provision to that market substantially. It enables Swiss Re to continue meeting the Australian market's increased demand for capital and to partner with clients in their capital management."
