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In Exhibit 1, the ‘protection buyer’ or re/insurer
enters into a reinsurance contract with the special
purpose reinsurance vehicle. Under the terms of the
Special purpose
contract, the re/insurer pays a quarterly reinsurance
reinsurance vehicle

Sponsor or
premium to the vehicle in exchange for protection
Collateral held in
principal at maturity
protection buyer
trust account
institutional buyers
against contingent liabilities, which may arise following
protection par amount
the occurrence of one or more natural catastrophe
As the special purpose vehicle has minimal equity
capital and does not carry a financial strength rating,
Swap counterparty
it raises capital to support its contingent obligations
by issuing catastrophe bonds to qualified institutional
buyers seeking diversified exposure to natural TABLE 2: OVERVIEW OF COMMON TRIGGER TYpES WITHIN
catastrophe events. The proceeds of this issuance are CATASTROpHE BOND TRANSACTIONS
held in a collateral trust account in the form of highly
rated, short-dated corporate bonds or, more recently,
Indemnity • Based on the actual, verifiable insured losses of the sponsor
government securities. In the event of a qualifying
• Basis risk for the protection buyer is minimised
loss, this collateral would be liquidated to meet the
Transaction example: Residential Re ltd (uSAA, 2009)
claim made.
Modelled loss • Based on the modelled output result of actual event parameters run
The catastrophe bond investor accepts the risk of
through the sponsor’s predefined exposure data set
• Model provided by one of the insurance industry’s third-party vendor
losing some or all of its principal from the occurrence
firms, such as RMS, AIR or EQECAT
of a qualifying natural catastrophe event that, in and
• Basis risk for the protection buyer exists but is somewhat minimised
of itself, has no direct relationship to the performance
subject to the accuracy of the exposure data set provided
of the global capital markets. In exchange for assuming Transaction example: Calabash Re III ltd (Ace ltd, 2009)
this risk, the investors are compensated with regular
Industry loss • Based on the index level published by a third-party index provider,
coupon payments. Prior to the lehman brothers index which estimates the total insured loss suffered by the insurance
bankruptcy in September 2008, investors in the asset
industry from a defined event
class often required a london Interbank Offered rate
• Trigger can be modified with state weighting factors to more accurately
reflect the sponsor’s geographic exposure portfolio
(lIbOr) based coupon. To achieve this, the special
• Index provider is commonly the Property Claim Services in the US
purpose reinsurance vehicle would enter into a total
• Similar to the model loss trigger, basis risk exists for the protection buyer
return swap (TrS) transaction with a swap provider
example: Mystic Re II ltd (liberty Mutual, 2009)
(such as an investment bank) to exchange the investment
parametric • Based on a measured reading such as sustained wind speed in a
returns on the collateral account for a regular lIbOr specific geographic location
return. This lIbOr return, in addition to the risk
• Basis risk is usually highest for protection buyers under parametric
premium paid by the re/insurer to the special purpose
transactions where the protection buyer is an insurer. However,
reinsurance vehicle, is used to fund the total amount
corporates (that have a developed understanding of their exposures
in a single specific risk location) have been amenable to parametric
of the coupon payment made to the investor. The
triggers for protecting assets in specific locations
structuring of catastrophe bonds with respect to the
example: drewcat Capital ltd (dominion Resources, 2006)
collateral account has been dramatically revised since
the lehman’s bankruptcy and is discussed in greater
detail below.
Following hurricane Katrina in 2005, and the impairment of US wind indemnity-based
The risk transfer contract between the re/insurer
catastrophe bond Kamp re ltd (sponsored by Zurich Financial Services), indemnity triggers
and the special purpose reinsurance vehicle can
fell out of favour among catastrophe bond investors. As a result, the other trigger types listed
be structured in a variety of ways. In particular, the
above became more prevalent in 2006 issuances.
re/insurer has the opportunity to choose which type of
Following a number of benign loss years, catastrophe bond investors have become once again
‘trigger’ will be used in determining whether a covered
more willing to accept indemnity transactions, as illustrated below.
event has occurred within the specifications of the deal.
because this choice introduces the potential for ‘basis
risk’ between the loss experience of the re/insurer and CATASTROpHE BONDS BY TRIGGER TYpE 2005-06 2009
the collection it may be able to make following a given
Hybrid 5.7% 18.3%
event from the special purpose reinsurance vehicle,
Indemnity 7.0% 33.4%
there are distinct differences between transactions in
Index 32.0% 20.9%
terms of how much risk is transferred to the capital
Model loss 20.2% 15.6%
markets investors and what risk, if any, is retained by
parametric 35.0% 11.9%
the sponsor. A summary of the prevalent trigger types
is provided opposite.
Total 100.0% 100.0%
58 | INTELLIGENT INSURER | September 2009
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