September 3, 2001.
By Morton N. Lane and Roger G Beckwith
INTRODUCTION
In
November 2000 Munich Re entered into a financial swap transaction with
a special purpose vehicle, PRIME Capital Hurricane Ltd. (PRIME), to
protect itself against losses resulting from severe hurricanes hitting
defined areas of New York and Miami. PRIME in turn funded its swap (or
counter party) obligation by issuing securities to capital market
investors. It issued $6 million Class B preference shares and $159
million Floating Rate Notes. PRIME agreed to pay its note purchasers
an interest rate of LIBOR plus 650 basis points quarterly for the next
three years. At the end of the three years the investors receive
return of their principal, if no hurricanes of the requisite intensity
have blown in the designated areas of New York and Miami. If an
adverse wind has blown, investors could lose all or part of their
principal.
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TMCC vs. USAA, August 31, 1998.
Any
paper titled as such should probably begin with, "It was the best of
deals, it was the worst of deals," but that is not the case with these
two securities. Rather it is the case that these two securities
represent the two largest, and similarly sized, transactions to date in
the burgeoning world of insurance securitization and yet display some
remarkable contrasts.
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Arbitraging Insurance Risks v1 |
December 22, 1998
On
July 16, 1997, Swiss Re Financial Products, in cooperation with Credit
Suisse First Boston completed a bond offering of $137 million in
California Earthquake Bonds. The total amount of insurance risk
transferred in the bond was $112.2 million. The size of the bond made
it the second largest insurance securitization of the seven completed
prior to that date. Previous issues sponsored by Goldman Sachs, Credit
Suisse, and Citibank, had been based on a book of underwritings of
particular ceding insurers, namely St. Paul Re, USAA, Winterthur and
Hannover Re. The Swiss Re California Earthquake Bond in contrast was
similar to the previous issues sponsored by both Sedgwick Lane
Financial (for Reliance) and AIG, namely it was based on index of
insured losses. As such, it was the largest indexed insurance-linked
note.
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Arbitraging Insurance Risk v2 |
July 18, 1997. Also published in Global Reinsurance, Vol. 6, Issue 4, Monte Carlo 1997.
Investors
who intended to purchase the recently issued United Services Automobile
Association (USAA) Insurance-Linked Note needed to satisfy themselves
that the pricing of this novel security was appropriate. The
investment bankers involved in the transaction (Goldman Sachs, Merrill
Lynch and Lehman Brothers) needed to assure investors that the price
was fair, or even superior. Among the reassurances given were that (a)
USAA itself would share in at least 20 percent of the subject risk
alongside the investor, (b) an independent auditor would assess the
claims, (c) an independent index (a meteorological trigger of storm
categories) would be required, (d) a third-party risk-assessment firm
(Applied Insurance Research) would provide estimates of the probability
of such storms and their likely effect on USAA’s book of business, (e)
a note rating would be provided by the recognized independent rating
agencies for certain of the securities, and (f) finally, and perhaps
most comforting, that reinsurers themselves (experts on the pricing of
such risks) were buying the notes for their own portfolio. Evidently,
all of these efforts worked. The note (issued June 16) was the largest
Insured-Linked Note issued to date and was oversubscribed by a factor
of nearly 2.5:1.0.
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