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TOKYO -- Tokio Marine & Fire Insurance Co. Ltd., Japan's largest non-life insurer and the world's second largest, has developed the first securitization of Japanese earthquake risk.
The company has purchased a fully collateralized earthquake risk coverage of $90 million through a 10-year, $100 million catastrophe bond issue by Parametric Re Ltd., a Cayman Islands-based special-purpose reinsurer owned by a charitable trust.
Goldman Sachs & Co. in New York and Swiss Re Capital Markets Corp., a subsidiary of Swiss Reinsurance Co., led the underwriting of the transaction. Earthquake risk analysis was provided by San Francisco-based EQE International Inc.
In contrast to Swiss Re's previous catastrophe bond for California earthquake risk, the present transaction is tied to the occurrence of an earthquake within a defined area around greater Tokyo rather than the insurance losses accrued, said Jorg Stoll, director of the Zurich-based Swiss Re subsidiary, Swiss Re Capital Markets.
The total $100 million bond deal was issued in two tranches:
$80 million in notes rated Ba2 and BB by Moody's Investors Services and Duff & Phelps Credit rating Co., respectively.
$20 million in units rated Baa2 and BBB- by the same agencies.
Investors have indirectly assumed a portion of Tokio Marine's insurance exposure to earthquake in the Tokyo area. The notes offer a high coupon rate which is the six-month London Interbank Offered Rate plus 430 basis points to compensate investors for the risk of principal loss, Tokio Marine said in a statement.
LIBOR, the rate at which prime banks operating in the London Eurocurrency market offer Eurodollar deposits to other prime banks, is frequently used as a standard in pricing bond deals.
The units consist of one part notes and one part certificates that put 50% of investors' principal at risk or, at the investors' choice, provide full repayment of principal, though over an extended period. The coupon rate on the units is the six-month LIBOR plus 206 basis points, Mr. Stoll said.
Loss payments are triggered by the occurrence of an earthquake of 7.1 magnitude, as determined by the Japan Meteorological Agency. The earthquake must be located within an area defined by geographical coordinates and depth around greater Tokyo.
Liability is graduated according to the magnitude of the earthquake, ranging from 25% for a 7.1 magnitude event to 100% for a 7.7 magnitude event, Mr. Stoll explained. Multiple events are covered in the transaction, but there is a limit of one event per 30-day period. "This is to prevent losses from immediate aftershocks," Mr. Stoll explained.
When the capital falls below 25% of the $90 million of coverage, the bond issue will be closed. "It will not be worth running after that," Mr. Stoll said.
Despite the turmoil in the Asian capital markets, the issue was more than four times oversubscribed, Mr. Stoll said. "Payment is guaranteed by Tokio Marine and Swiss Re, which are triple-A rated companies. The money is in the Cayman Islands. This has nothing to do with the (Asian) economy. Even if everything goes bust in Asia, nothing affects this bond," he added.
But there was concern about investor reaction prior to the issue. "We have been somewhat anxious to see how investors would react," said Yuichi Takeda, deputy manager, non-marine underwriting department at Tokio Marine's head office in Tokyo.
During the book-building period, investors were interested in opportunities in diversifying risk, he said. Eventually more than 50 institutional investors from the United States, Canada, the United Kingdom and Germany subscribed, he said.
Tokio Marine's earthquake exposure concerns industrial risk. Residential risks are 85% covered under a government-sponsored plan. The company's future earthquake exposure in various construction types over the 10-year period of the bond has been worked out using an in-house model.
But the bond represents only a small proportion of Tokio Marine's total earthquake exposure, itself only a fraction of total fire exposure. Total industrial fire policies with earthquake coverage have an aggregate exposure of units of hundreds of billions of yen, Mr. Takeda said. By comparison, fire policies in the South Kanto area have an aggregate exposure of 123 trillion yen.
The development of the earthquake bond is part of Tokio Marine's strategy to meet new client demand expected after the deregulation of the Japanese financial market next year. Existing government controls on tariffs and types of services will be abolished, Mr. Takeda noted.
The complete opening of the financial sector is slated for the year 2001 and has been dubbed the "Big Bang." Both foreign and national banks will then be able to get into the Japanese insurance sector.