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State Farm to launch giant cat bond

US insurer State Farm is set to place a giant $4bn cat programme, consisting of both bonds and loans, to provide retrocessional protection for one of its subsidiaries.

The company has formed a special purpose vehicle, called Merna Re, which will provide fully collateralised, three-year aggregate catastrophe excess-of-loss retrocessional protection to Oglesby Re, a special purpose vehicle.

The proposed cat bond, which is thought to be the largest ever, is another firm indication of the capital market’s current appetite for reinsurance risk. It is also significant as it is structured as an indemnity bond, whereas investors have recently favoured parametric or index-based triggers.

Oglesby Re provides catastrophe excess-of-loss reinsurance to State Farm Mutual covering risks including homeowners and small businesses. The risks will be laid off through a combination of notes and bank loans. Proceeds from the debt offerings will be placed into trusts as collateral for potential claim obligations to Oglesby Re.

Moody’s Investor Services analyst Kevin Lee said: “Merna Re’s structure resembles that of an indemnity catastrophe bond except that investors will provide cumulative - rather than single year - aggregate excess-of-loss protection over three years.”

Moody’s has assigned provisional ratings to Merna Re’s five tranches of proposed debt securities, Tranche A $500mn Aa2; Tranche B $1.2bn A2; Tranche C $850mn Baa2; Tranche D $690mn Ba2 and Tranche E $780mn B2.

Unusually, for a cat bond the attachment points are built across State Farm’s US portfolio rather than for a specific peril in a pre-defined geographical area. Net losses to Oglesby Re will be set against probability curves derived by an AIR Worldwide model.

Moody’s commented: “Based on AIR's modeling of historical events, the 2003-2005 hurricanes would have, hypothetically, caused an $82mn loss to the lowest debt tranche. Further, based on AIR's modeling of historical events, the sum of the three worst years of modeled losses to Oglesby Re (i.e., 1812, 1886, and 2005) would not have impaired the highest debt tranche, hypothetically.”

The homeowner and small business policies covered by the transaction were easier to model than industrial or commercial risks, it added.

Moody’s concluded: “Oglesby Re’s participation in the program will sit alongside that of external reinsurers, and the reinsurance agreements between State Farm and Oglesby Re will mirror those between State Farm and external reinsurers. In this respect, there is little opportunity for adverse selection.

“Furthermore, losses caused by certain un-modellable perils, like riots unrelated to covered perils, will be passed on to Oglesby Re but not to Merna Re.”

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