Mexico’s Fund for Natural Disasters FONDEN, a government fund that provides aid to the general population after natural catastrophes, has obtained insurance cover for certain earthquake and hurricane risks.
FONDEN has entered into an insurance contract with Mexican state-owned insurer Agroasemex.
Swiss Re is counterparty to the deal and will reinsure Agroasemex to enable the insurer to pay any claims made by FONDEN for qualifying catastrophes.
The deal is structured around the issuance of a catastrophe bond sponsored by the fund.
The $250 million cat bond, issued by Multicat Mexico 2009 Ltd through a Cayman Islands-based special purpose vehicle, will cover any losses related to the insurance payouts following defined catastrophic events.
The notes will provide protection to FONDEN for three years, from October 2009 to October 2012, from Mexican earthquake and hurricane events.
The Multicat-Mex bond replaces a previously issued Mexican cat bond, which provided coverage against earthquakes and is due to expire.
Cat bonds are a means by which insurance and reinsurance companies transfer their risk exposure to natural catastrophes to capital market investors.
Cat bonds pay a higher than usual coupon because the payout of the bond is linked to a specified form of natural catastrophe or disaster and investors will lose some or all of their investment if such a pre-defined event occurs.
The proceeds from the sale of a cat bond must be invested into AAA-rated collateral such as treasury bills. In the event of a catastrophe the bond defaults and the collateral is sold to cover the losses the bond sponsor incurs as a result of the disaster.
If no catastrophic event occurs the money is returned to the investor, typically at the end of three years.
Cat bonds appeal to investors through their high returns of 8 to 10 per cent above Libor and their low correlation with the rest of the market, for example the credit markets.
The Multicat-Mex protection will only cover earthquake and hurricane events of a specific magnitude in defined areas.
AIR Worldwide Corp will function as the event calculation agent and verify the event conditions that trigger a bond default on the basis of data reported by the United States Geological Society for earthquakes and the National Hurricane Centre for hurricanes.
The cat bond is structured in four classes of notes. Class A notes provide cover for earthquakes meeting certain parameters of strength and depth in three zones. The default triggers are earthquakes at a depth of less than 200 Km and above a magnitude of 7.9 in Zone A, above 8.0 in zone B and above 7.4 in Zone C.
The Class B and C notes are exposed to Pacific hurricanes with a minimum central pressure of below 944mb.
Class D, which is exposed to Atlantic hurricanes, requires a storm with a minimum central pressure of 920mb or lower to trigger a default.
Tranches A,B and C were all rated ‘B’, whereas tranche D was rated ‘BB-‘ by Standards and Poor’s.
Munich Re has been advising on the deal and Bank of New York Mellon functions as the trustee.