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The recent announcement that New York's Metropolitan Transportation Authority bought a $200 million catastrophe bond demonstrates the challenges faced by large insureds to secure adequate insurance coverage in catastrophe-prone regions, as well as the ability of insurance-linked securities to augment or even replace traditional insurance and reinsurance coverages.
When Superstorm Sandy barreled onto the East Coast last October, no entity bore the brunt like the MTA, which owns a network of train, bus and subway network infrastructures in New York City and surrounding areas. With tunnels and subway stations flooded, the MTA estimates it will cost $4.75 billion to repair the damage caused by Sandy's deluge of wind and rain.
This tally was no doubt on the mind of insurance underwriters when time came for the transportation authority to renew its property insurance program in the spring.
“Our program expired on May 1 and it was a difficult renewal for us,” MTA Director of Risk and Insurance Management Laureen Coyne said. “We saw contraction in the market and pricing increases, and we were not able to get the same traditional reinsurance that we had.”
This realization forced the MTA's risk management team to take a look at the catastrophe bond market, Ms. Coyne said. “After Sandy, we realized that we needed another option” for coverage against natural disasters, she said.
The result was a first-of-its kind catastrophe bond, MetroCat Re Ltd., which will benefit the MTA's captive insurance company, First Mutual Transportation Assurance Co., and deal solely with storm surge and rely on measurements from a collection of tidal gauges surrounding New York City to trigger. The three-year bond was created with the help of New York-based GC Securities, a division of MMC Securities Corp., as well as Newark, Calif.-based catastrophe risk modeling firm Risk Management Solutions Inc. and St. Petersburg, Fla.-based financial advisory firm Raymond James & Associates Inc.
The novelty of the bond structure, as well as the need to secure the requisite number of investors in the tight time frame between renewal season and the onset of the Atlantic hurricane season in the summer, proved a challenge, MTA Senior Manager of Strategic Initiatives Nora Ostrovskaya said.
“The traditional insurance process is a very well-known process, even if we don't know exactly what our broker will come back with,” Ms. Ostrovskaya said. “With catastrophe bonds, it was an entirely new process for us, starting with the selection of the firms to advise us.”
Ms. Ostrovskaya said the transparency provided by parametric triggers in the bond, which are based on data received from existing tidal gauges, are run by the United States Geological Survey and the National Oceanic and Atmospheric Administration. They helped assuage fears when the MTA presented the bonds to potential investors.
“This is the first solely storm surge-based parametric transaction in the market,” she said. “So we wanted to make sure the investors knew that the triggers were transparent and not subject to our control.”
Duncan Ellis, New York-based U.S. property practice leader at Marsh Inc., the MTA's insurance broker, said the certitude surrounding the triggering of the bonds was attractive to investor and sponsor alike.
“The nice thing about these bonds is that they are either triggered or not triggered,” he said. “You don't have the grey areas around as you would have around a traditional insurance policy, about whether the damage was caused by wind, flood or surge.”
Indeed, the bonds do not address many of the more contentious issues found in a traditional property policy such as proximate cause of loss, contingent business interruption and ingress and egress issues, Mr. Ellis said.
This relative simplicity and increased demand for catastrophe bonds from investors leads some to think they will play an increasingly important part in primary insurance programs for large public entities in addition to their traditional role in the reinsurance market.
“We have already been seeing, with regards to reinsurance and retrocession, the use of alternative capacity has continued to grow,” said Cory Anger, global head of ILS structuring at GC Securities. “This transaction demonstrates that it can apply to the insurance market and is a tool for corporations and governments institutions to hedge their risk.”
William Dubinsky, New York-based head of insurance-linked securities at Willis Capital Markets & Advisory, said that insureds accessing the capital markets directly for coverage is relatively rare.
He called it “the exception rather than the rule.”
Mr. Dubinsky said that the transactional costs for catastrophe bonds have come down, but said that directly accessing the capital markets for insurance coverage makes sense only for the largest or hardest-to-place risks.
For example, he said in a traditional insurance arrangement, the prices you would pay for $2 billion in limits are proportionately more than what you would pay for $250 million in limits, if the primary coverage was available at all.
“As the economics of (catastrophe bonds) improve and the cost of doing the deals and the bond spreads come down, those things become more achievable,” he said.
Ms. Ostrovskaya said catastrophe bonds likely will figure in the mix of risk-shifting techniques the MTA uses in the future.
“Cat bonds are a tool,” she said.
“We do not feel obligated to use them. But as we move forward, if we find an appropriate use for this tool to replace traditional insurance, we have that option.”