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MORRISTOWN, N.J. -- A recent catastrophe bond issued to finance reinsurance protection for F&G Re Inc. transfers higher-risk exposures into the capital markets than most prior deals.

The $54 million deal, completed earlier this summer, also allows The St. Paul Cos. Inc., the parent of F&G Re, to make another foray into the capital markets while expanding its book of reinsurance business.

As with several other cat bond deals, this transaction uses a Cayman Islands-domiciled special-purpose reinsurer, Mosaic Re, to issue the bonds, with the proceeds funding a reinsurance contract for Morristown, N.J.-based F&G Re.

Goldman, Sachs & Co. and E.W. Blanch Capital Markets led the underwriting on the one-year securities, whose return to investors varies with F&G Re's underwriting experience on a defined portfolio of reinsurance contracts that are covered by the aggregate excess-of-loss retrocessional policy written by Mosaic Re. The coverage period of the one-year Mosaic Re policy ends July 1, 1999.

Dwight Evans, executive vp at St. Paul Re in New York, noted that F&G Re began looking into doing a capital markets deal last year, before its parent, USF&G Corp., was acquired by St. Paul and the reinsurer was subsequently combined with St. Paul Re.

"We wanted the capability to access the capital markets to leverage our underwriting capabilities," he said. The company also wanted to use the capital markets financing to write new business, not simply as a vehicle for transferring existing exposures. "We didn't want to cannibalize our book and give away business that we already had in one way or another."

The company began talking with intermediary E.W. Blanch at the end of 1997. "It was a good partnership because this defined portfolio that Mosaic Re protects was really new business to F&G Re," Mr. Evans said.

The risk transferred to investors was slightly higher than in previous cat bond deals because the layer of risk involved was lower than in those earlier transactions.

"What we wanted investors to do was participate in the business in the same way we did," Mr. Evans said. At high-level excess coverage, "it's effectively earthquake and wind only," he said. "This coverage was essentially all perils that we provide our clients."

"Most of the other deals have been where the probability of a first-dollar loss was in sort of the 1% range," agreed Keith M. Buckley, senior vp in the insurance ratings division of Duff & Phelps Credit Rating Co. in Chicago, which rated the transaction. "With this deal, the probability of first-dollar loss was closer to the 5% range."

Mr. Buckley noted that two different tranches of notes in the deal exposed investors to different levels of risk.One that carries a 5% probability of first-dollar loss got a B rating from Duff & Phelps, while a second tranche, with a loss probability closer to the 1% typical on other cat bond deals, got a BB rating.

Investors in the riskier tranche will earn the London Interbank Offered Rate plus 827 basis points, while the lower-risk tranche will pay LIBOR plus 444 basis points.

St. Paul Re was one of the first reinsurers to venture into the capital markets, with a December 1996 deal that provided it with $68.5 million in property excess-of-loss and property catastrophe protection.