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Insurance-linked securities sector grows with emergence of 'cat bonds lite'

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The insurance-linked securities sector continues to expand through traditional catastrophe bonds, but it is also getting some help from smaller private placements that are known as “cat bonds lite.” The instruments are smaller transactions and require less robust documentation and disclosure than traditional cat bonds issued under U.S. Securities Act Rule 144A.

From the absence of third-party modeling to the production of fewer documents, these “lite” cat bonds allow cedents and investors quicker, less expensive access to the insurance-linked securities market, and they typically cover U.S. wind and earthquake risks.

While it's “difficult to quantify” the cost and time savings in a cat bond lite vs. a traditional cat bond, “suffice it to say, the cost savings and time to complete a cat bond lite is significantly less costly and time-consuming than that of a 144A cat bond,” said Asha Attoh-Okine, managing senior financial analyst at A.M. Best Co. Inc.'s insurance-linked securities group in Oldwick, New Jersey.

“A key element in the opening up of the insurance-linked securities sector is the development of products which offer reduced frictional costs, and which also meet investor liquidity and structural requirements,” Robert Eastham, managing director of Kane Bermuda, part of Kane Holdings Ltd., said in an email. “The emergence of cat bond lite structures is a key step in this evolution.”

Frictional costs can be 50% to 75% less for lite cat bonds vs. traditional cat bonds, with time savings of about 50%, said Michael Popkin, New York-based co-head of insurance-linked securities at Jardine Lloyd Thompson Capital Markets Inc., a unit of JLT Towers Re.

“Cat bond lite has reduced the complexity and cost of bonds in order to give a boost to new issuance,” said Jennifer Donohue, a consultant at law firm Locke Lord L.L.P. in London.

“These transactions ... enable investors to access the ILS arena at a much lower entry point, with trades ranging from approximately $5 million to $50 million,” Mr. Eastham said.

Such instruments are “easily accessible to small and medium-size insurers, the documentation is streamlined, and the structuring costs are very low,” Best's Mr. Attoh-Okine said.

Cat bond lite deal sizes typically range from $10 million to $50 million, said Mr. Attoh-Okine, compared with $100 million or more for a standard instrument.

Most standard catastrophe bonds require 20 or more documents, which can be time consuming, expensive and daunting to new market participants, said Brad Adderley, a Bermuda-based partner in the corporate department of the Appleby law firm.

“There's no question people are forming platforms to allow clients to do small transactions, to be able to get to market more quickly, and to give more access to clients who don't want to spend the money to come up with all the needed documentation,” Mr. Adderley said.

One such route is Kane's SAC Ltd. platform, designed for lite cat bonds of $10 million to $50 million. The service was launched in August 2013 and has hosted a variety of transactions. A $54.8 million January placement in its Exeter Segregated Account collateralized a property catastrophe reinsurance contract for an undisclosed buyer through Jan. 15, 2016.

A key aspect of the SAC platform is the notes began trading this year on the Bermuda Stock Exchange, opening them to a wider pool of investors. “Some investors require that a security be listed, otherwise they cannot buy it,” Mr. Adderley said.

Another leap forward this year is clearing such cat bond lite trades through Brussels-based post-trade service provider Euroclear P.L.C., which helps open up the potential of the secondary market through enhancing liquidity by allowing investors to trade notes over the counter using a recognizable system.

Other lite cat bond platforms include JLT Capital Market's Market Re, launched last May, and the Tokio Tensai Platform that Tokio Solution Management Ltd. and GC Securities rolled out in June 2013.

Platform-based, exchange-cleared trading will make the insurance-linked securities market more attractive to investors who don't want to do big deals or find the traditional process too slow and cumbersome, Mr. Adderley said.

While several platforms have focused on smaller cat bonds, another market player has tried to simplify the process for standard cat bonds.

Aon Benfield Securities' CATstream was established last summer “so middle market and smaller companies that have smaller property catastrophe programs, as well as corporate clients, can access it without having to consider a minimum transaction size needed to create efficiencies,” said Paul Schultz, the Aon P.L.C. unit's Chicago-based CEO.

CATstream utilizes templated documentation and third-party modeling and Aon Benfield models to reduce costs associated with traditional cat bonds, he said.