While insurance-linked securities are often marketed for their “non-correlation” to credit and equity markets, ILS would not be spared losses following a possible breakup the Eurozone, according to a report issued by Aon Benefield Securities.
“Some market commentators believe that a potential Greek exit, severely unsettling for the whole area, could be a forerunner to a partial or full break-up of the Eurozone,” says Aon’s Benfield’s Second Quarter Insurance Linked Securities Update issued Wednesdat. “In this instance, the catastrophe bond market will no longer be immune to the effects of a break-up.”
Catastrophe bonds and other ILS structures with exposure to European Union could be subject to an “early redemption event” that would allow cedents to terminate the transaction if the Euro ceases to exist as a currency, the report states. The report did not say how an early redemption would impact investors.
Alternatively, catastrophe bonds that insure on an indemnity or indexed basis — and are associated with losses in an existing Eurozone country — would face struggles in converting and measuring losses if the currency were to cease to exist.
“The above development does add a degree of currency risk for investors,” the report states. “Modeled risk analysis for catastrophe bonds during this uncertain time will not be able to adjust for the impact of currency changes, except upon future resets. It is still not clear if this impact will be positive or negative.”
The report – which references the law firm of Mayer Brown — says that several recent ILS issuers have attempted to address a breakup of the Eurozone with different conversion mechanisms at the outset of the deal.
Some deals have included a provision where losses in an event can be determined in the “new local currency” and then converted into Euros at the rate established at the time of departure.
Additionally, European catastrophe loss tracking consortium PERILS AG “indicated” it would apply a conversion rate for any new currency of a departing country at the time of the loss event.
PERILS-based indexes in countries outside the currency union — including such as Denmark, the United Kingdom and Switzerland — could also report losses in local currency and convert losses to Euros, the Aon report said.