Lloyd’s of London and catastrophe go hand in hand. So much so that members of the London insurance market could be forgiven for feeling that Lloyd’s has been nothing but a catastrophe in recent years.
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The Lloyd’s building: The market’s syndicates are familiar with catastrophe |
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But the link with catastrophe took a new twist in April when Hiscox – one of the market’s largest and best regarded underwriters – became the first Lloyd’s syndicate to tap the insurance securitization market, placing $33 million of catastrophe risk-linked bonds via Aon Capital Markets.
The transaction had its origins months ago when Lloyd’s and Goldman Sachs got together to discuss the possibility of a multi-syndicate catastrophe securitization.
This proved unworkable since it was difficult to align the needs of different syndicates. Goldman lost interest, Aon’s investment banking subsidiary stepped in and Hiscox decided to go it alone.
Syndicate 33 at Lloyd’s – managed and majority owned by Hiscox – securitized a neatly sized $33 million of California and New Madrid earthquake risk, using proprietary risk-modelling systems provided by Risk Management Solutions.
St Agatha Re – named after the patron saint of earthquakes – is a three-year offering of notes, priced at three-month Libor plus 675 basis points and rated AA+ by Standard&Poor’s.
According to Charles Arthur, alternative risk transfer specialist at Hiscox, the cat bond removes the credit risk associated with traditional reinsurance policies, at a time when the universe of highly rated reinsurers is shrinking.
It also offers a new source of liquidity, with the bonds being sold exclusively to non-insurance fixed-income investors. And it provides swift payment in the event of loss.
For investors, the notes offer a substantial pick-up – almost double the 350bp spread on a similarly rated corporate bond. Strong demand meant that Hiscox and Aon were able to tighten the pricing by some 175bp from initial indications.
“We are always looking for ways to buy reinsurance cost effectively and avoid credit risk,” says Arthur. “Our analysis suggested that a) the price was attractive, and b), if we had been looking to place that amount of California risk in the traditional reinsurance market, we wouldn’t have been able to do it.”
Complex technology
Until now, the high costs and complex technology involved in cat bond deals have meant that most transactions have been for sponsors requiring larger amounts of reinsurance cover than typically purchased by Lloyd’s syndicates.
A more typical deal, launched just after Easter, was the $200 million Redwood Capital transaction for Swiss Re, arranged by Lehman Brothers.
By using relatively simple technology and risk modelling, Hiscox was able to bring down the costs of the transaction. “The frictional costs of cat bonds are legendarily large,” says Arthur.
“But what we lost in terms of the cost of setting up the deal [by going solo rather than with other syndicates], we won on the pricing as a result of structuring a bond that was transparent and easy to understand.”
Richard Godfrey, director of Aon Capital Markets, says: “We were very pleased with the pricing we got. Investors liked the simplicity of the deal.”
Arthur said Aon – which has underwritten over $1 billion of cat bonds and is the leading player among the insurers by some way – was a natural choice as arranger.
“For a start they understand the insurance business – which is an advantage,” says Arthur. “Even more important, they understand the special characteristics and needs of Lloyd’s.”
Whether Hiscox’s innovation encourages other Lloyd’s syndicates to follow suit remains to be seen. Aon says it is working on a number of other possible deals, including others for Lloyd’s syndicates. But it has certainly brought an air of sophistication to a marketplace that has signally lacked that quality in recent years.
