A.M. Best Analyst: Future of Thunderstorm-Only Cat Bonds Is Cloudy

The first catastrophe bonds issued to cover severe thunderstorms alone have been triggered, resulting in total losses for investors and clouding the future of similar transactions in the future, said Asha Attoh-Okine, managing senior financial analyst of insurance-linked securities for the A.M. Best Co.

Two cat bonds issued under Mariah Re Ltd., which were issued in 2010 by American Family Mutual Insurance Co., have been triggered, may lead to releasing $200 million to American Family, Attoh-Okine said.

One cat bond for $100 million provided excess-of-loss reinsurance coverage over $725 million. A second, rated cat bond for another $100 million provided excess-of-loss reinsurance coverage over $825 million. Both cat bonds provided protection on an annual aggregate basis over a three-year risk period but were triggered in their first year.

If another severe thunderstorm-only cat bond comes to the market, investors may expect a higher return due to the higher perceived risk, Attoh-Okine said.

A more likely scenario might be the next time severe thunderstorm risk is covered by a cat bond, the bond would also include other perils.

"This outcome tells you it is not a free ride," Attoh-Okine said.

While American Family will probably recoup $200 million from the cat bonds, that coverage is now exhausted so the company will have to seek reinsurance coverage again for that program, Attoh-Okine said.

Modeling severe thunderstorm losses can be tricky, due to lack of formal reporting in the early 1970s and changes in population dynamics, Attoh-Okine said. Severe thunderstorm risks include risks of tornadoes, windstorms and hailstorms.

As of November, about $3.8 billion in cat bonds had been issued or were pending to be closed this year, compared with $4.3 billion in 2010 and $3.4 billion in 2009, according to A.M. Best data.

The overall cat bond market remains heavily weighted towards U.S. wind risk, with 67% of capital covering such events, down from about 71% last quarter, according to insurance broker Willis.

Mariah is not the only cat bond to be triggered this year.

The Japanese earthquake of March 11, 2011, led to a total loss of the $300 millionMuteki Re Ltd. cat bond, and the recent hardening of the Japanese market may encourage sponsors to issue more cat bonds, although also at increased cost, Attoh-Okine said (Best's Review, October 2011). Any changes in projected expected losses as a result of all these recent catastrophic losses would thus lead to an increase in risk premiums demanded by investors for future cat bonds covering these perils.

American Family Insurance Group currently has a Best's Financial Strength Rating of A (Excellent).

(By Meg Green, senior associate editor, BestWeek: [email protected])