Mexico Cat Bond May Portend Similar Structures

The recent $250 million catastrophe bond offered by the Mexican government — if marketed successfully — may be the first of many multi-peril bonds issued by sovereigns in the coming years.

Market professionals will closely watch its success to see if the bond will spur other governments to take the plunge.

“Since the market opened back up earlier this year, there has been significant interest in multi-cat,” says Dennis Sugrue, analyst with Standard & Poor’s in London. “Mexico is a real test case.”

Last week, S&P issued a pre-sale credit rating on Multi Cat Mexico Ltd., which is a successor to the $160 million Cat-Mex Ltd. vehicle that is set to wind up this year.

Unlike the preceding Cat-Mex structure, which only covered earthquake risk, Multi Cat-Mex covers both earthquake and hurricane risk through multiple share classes.

The class A notes will cover $100 million within earthquake risk in a three-zone region in Mexico. The remaining B,C, and D notes of the bond will cover hurricane risk across the Atlantic and Pacific shores of Mexico for losses up to $50 million each.

Multi-cat structures are nothing new to the catastrophe bond market, with approximately 16 percent ($127.6 million) of second-quarter issuance dedicated to multiple-peril structures, according to broker Guy Carpenter.

But while the structure of the bond is not necessarily innovative, Sugrue says the move by the Mexican government to greatly expand the scope of its program is telling.

“The expansion of the commitment is significant,” Sugure says. “I think the market wants to see if other countries react.”

Sovereigns directly issuing catastrophe bonds has been the Holy Grail for many participants in the market, opening up the floodgates beyond limited reinsurance and carrier participation.

But sovereign involvement has been limited. Mex-Cat was the most notable government-sponsored issue to date. Earlier this year, the quasi-governmental North Carolina Joint Underwriting Association and the North Carolina Insurance Underwriting Association issued $200 million in bonds to cover hurricane risks.

Some New Territory

The structure of Multi-Cat Mex relies on conservative collateral arrangements and untested models that may also be the shape of things to come if other countries enter the market.

According to the S&P report, collateral for Multi-Cat Mex will require U.S. Treasuries and highly rated U.S. money market funds with maturities less than 12 months. The collateral in Mexico’s prior cat bond issuance — Cat-Mex — included a LIBOR spread.

Sugure said this was likely a reaction to the losses many catastrophe bonds experienced last year during the collapse of Lehman Brothers.

“There has been a move away from LIBOR and swap structures that could continue for some time,” he said.

Multi-Cat Mex will also be the first catastrophe bond to use the Mexico Cyclone Model created by AIR. The model — released in April of last year — covers hurricane risk in Latin America.

While S&P says the AIR model is sound when used in conjunction with larger parametric triggers, but remains untested and includes assumptions based on Caribbean models because of the lack of data on Pacific storms.

“Taken in context, AIR is a very reputable firm,” Sugure.

Representatives from AIR declined to comment.

If new regions attempt to tap the catastrophe bond market, they will also need a supporting cat model, something that is not always available in developing regions.

Efforts have been made to expand catastrophe modeling into emerging economies. For example, PERILS AG was created early last year to expand available data in Europe.

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