CHICAGO--(BUSINESS WIRE)--Fitch Ratings assigns ratings to the series 2014-1 principal at-risk variable rate notes issued by Tradewynd Re Ltd., a duly formed special-purpose insurer in Bermuda, as follows:
-- $100,000,000 Class 3-A notes expected to mature Jan. 8, 2018 'BB-sf';
-- $100,000,000 Class 1-B notes expected to mature Jan. 8, 2016 'Bsf' ;
-- $300,000,000 Class 3-B notes expected to mature Jan. 8, 2018 'Bsf'.
The Rating Outlook is Stable.
The series 2014-1 notes provide multi-year (or, in the case of the class 1-B notes, single-year), indemnity, per occurrence coverage to various insurance subsidiaries or affiliates of American International Group, Inc. (AIG) (Fitch IDR 'A-', Stable Outlook) for named storm and earthquake perils. Similar to prior notes issued by Tradewynd Re, coverage is expansive and covers both consumer (about 41% of the total net limit) and commercial lines. The consumer line is predominantly related to high net worth individuals and can include items such as homes with replacement values in excess of $1 million, yachts and art collections. The commercial line includes property (about 37% of the total net limit) such as airports and sport stadiums, energy and engineering risks (about 7%) such as pipelines and oil rigs and specialty risks (about 14%) such as airplanes (both large and small) and cargo and hull damage. Losses can include direct damage from the peril but also claims arising after the event such as, but not limited to, looting, fire following the event, sprinkler leakage or business interruption. The coverage area is the contiguous 48 United States (and territories and districts) plus Alaska and Hawaii, Canada, Mexico and the Caribbean islands plus Bermuda and the Gulf of Mexico. The Gulf of Mexico is for named storms only and excludes the earthquake peril.
Classes 1-B and 3-B are exposed to principal loss if a covered event exceeds $3 billion in covered losses. Class 3-A has a unique attachment point structure. At the onset, it is set at $4.5 billion but if the class 3-B notes experience any principal loss, the class 3-A attachment point will "drop down". For example, if the class 3-B note experienced a loss of two-thirds principal from an event, the class 3-A note attachment point drops down to $3.5 billion for the following covered event. If the Class 3-B note is totally exhausted, then for the following event, the class 3-A note assumes the class 3-B note position with an attachment point of $3 billion. Absent changes in exposures or risk appetite by AIG (subject to certain parameters), the class 3-A notes will be re-established at an attachment point of $4.5 billion on any reset date.
On a historical basis, AIG has not experienced any actual natural catastrophe losses that would have triggered a loss event on these three classes of notes. As a point of reference, AIG reported estimated ultimate net losses for Hurricane Katrina and Superstorm Sandy of $2.2 billion and $2.1 billion, respectively. It is estimated that these notes would not have been triggered using historical named storm paths with the current exposure base. Three historical earthquakes (New Madrid in 1811, San Francisco in 1906 and Charleston in 1886) would have caused a complete or partial principal loss with today's exposure base.
In the event of a covered loss, gross losses will be adjusted for explicit loss adjustment factors of 1.06 for consumer losses and 1.04 for commercial losses and currency exchange rates for losses outside the U.S. Ultimate Net Losses are the Adjusted Gross Losses less any inuring reinsurance multiplied by a Growth Limitation Factor which is the lesser of 1.0 and the ratio of the Growth Allowance Factor (1.10) and the Actual Growth Factor.
Class 3-A and 3-B have annual rate resets on January 1 of 2016 and 2017 which will reflect changes to the covered business exposure and changes to the risk appetite by AIG. This could lead to an increase (or decrease) in risk levels inherent in the notes. However, investors will be compensated with an adjustment to the interest spread.
Each class of notes may be extended up to three additional years if certain qualifying events occur. However, the notes are not exposed to any further catastrophe events during this extension period. The interest spread may be reduced if a covered event occurs. The notes may be redeemed at any time due to Early Redemption Events such as regulatory or tax law changes. The repayment of the notes to the noteholders occurs subsequent to any qualified payments to AIG for covered events. Noteholders have no recourse against AIG.
KEY RATING DRIVERS
The rating is based on the weakest link approach in the evaluation of the natural catastrophe risk, the counterparty risk of AIG and the credit risk of the collateral assets. The natural catastrophe risk represents the lowest rating amongst the three risk segments and currently drives the final rating of each note.
The rating analysis in support of the evaluation of the natural catastrophe risk is highly model-driven. As with any model of complex physical systems, particularly those with low frequencies of occurrence and potentially high severity outcomes, the actual losses from catastrophic events may differ from the results of simulation analyses. Fitch is neutral to any of the major catastrophe modeling firms that is selected by the issuer to provide the model analysis, and thus Fitch did not include any explicit margins or qualitative haircuts to the probability of loss metric provided by the modeling firm.
Risk Management Solutions, Inc. (RMS) provided the risk analysis using their proprietary software and risk models implemented as RiskLink version 13.1 and Miu version 2.9. These models will be escrowed and used by RMS in determining any future annual reset. Based on one million simulations, the one-year attachment probability for classes 1-B and 3-B was 3.35% while class 3-A was 1.43%. This corresponds to implied ratings of 'B' and 'BB-', respectively, using Fitch's ILS Calibration Matrix with a one-year time-to-risk maturity assumption. Various sensitivity tests performed by RMS produced modest increases in the attachment probabilities but not enough to change the rating category. Results from other third-party modeling firms or from AIG, which could indicate different levels of attachment probability, were not provided. Noteholders are exposed to this basis risk or the difference between actual net losses incurred by AIG and the RMS modeled net losses.
RMS is the calculation agent for each reset date. They will use updated exposures from AIG along with the initial attachment and exhaustion levels and the escrow model to calculate updated sensitivity case attachment probabilities and expected losses. As long as those probabilities do not exceed the Maximum Sensitivity Case Attachment Probability of 3.06% for class 3-A and 6.18% for class 3-B and the Maximum Sensitivity Case Expected Loss of 2.35% for class 3-A and 3.51% for class 3-B, then the attachment levels will not change. However, investors will be compensated with a corresponding increase to the interest spread for any increase in the expected loss. The adjustment to the Initial Risk Interest Spread will be an increase by a factor of 1.80 for class 3-A and 1.60 for class 3-B for every basis point increase in the expected loss. For example, if the class 3-B reaches its Maximum Sensitivity Case Expected Loss (3.51%), the Adjusted Risk Interest Spread will increase 1.76%.
The suite of models in RiskLink version 13.1 include "RMS North Atlantic Hurricane Models" (last updated in 2013), "RMS Hawaii Hurricane Model" (2007), "RMS North America Earthquake Models (2009) and RMS Caribbean Earthquake Models" (1999). The North Atlantic Hurricane Models include storm surge which are losses occurring with increase tidal waves washing onto surrounding low-lying areas. All models included loss amplification due to economic demand surge, claims inflation and "super-cat". Tradewynd Re specific costs of the consumer and commercial insurance adjustment factors and a currency conversion table were modeled. Secondary perils of fire following earthquakes and sprinkler leakage were included.
Since the covered business and covered losses are expansive, there are certain unmodeled risks in the transaction. Areas of additional uncertainty include: 1) hurricane losses cover the entire U.S. whereas RMS models the 21 primarily coastal states in the U.S. and eastern areas of Canada and Mexico, 2) potential hurricanes forming in the Pacific Basin, 3) losses due to tsunamis caused by earthquakes, and 4) losses that occur when wind speeds do not exceed 50 mph.
Ancillary losses such as inland flooding due to hurricane-related rainfall or due to dam or levee ruptures caused by earthquakes are not modeled. The analysis did not include the potential for a 10% growth in the underlying exposures. The model simulates only hurricane activity making landfall, thus it understates claim losses to named storms not recognized as hurricanes or hurricanes that become degraded.
Tradewynd Re is reliant on the counterparty credit risk of AIG to make periodic payments for the Risk Interest Spread. In the event that any payment is not made, principal will be returned to noteholders. In addition, the notes ultimately "follow the fortunes" of AIG over the next three years in regard to underwriting of new business, the availability of insuring reinsurance and claim loss management and reserve practices. The data quality and detail provided to RMS appears robust. An independent claim review is provided by KPMG (Bermuda) and the loss reserve specialist for Tradewynd Re is Ernst & Young (Bermuda).
In addition to state regulation, AIG is also subject to federal oversight since it was designated a systemically important financial institution (SIFI) by the U.S. Treasury pursuant to Dodd-Frank and also as a global systemically important insurer (GSII). This increased regulation may restrict certain business activities and could potentially trigger an Early Redemption Event.
Proceeds from this issuance will be held in a collateral account and used to purchase high-credit-quality money market funds meeting defined eligibility criteria, otherwise funds will be held in cash. Investment yields generated from these permitted investments are passed directly to noteholders as the other component of the variable rate. A downgrade of a permitted investment will not necessarily lead to a replacement of that investment. Further, noteholders are exposed to possible market value risk if the net asset value of a money market fund falls below $1.00 or is redeemed in adverse market conditions. Finally, certain actions may be required if the collateral account is invested in money market funds and FATCA is deemed to apply in late 2016.
A legal opinion regarding Tradewynd Re's consolidation with its owner, a Bermuda purpose trust, is not available. This opinion typically provides assurances that the issuer will not be consolidated with its owner in the event of its owner's insolvency and is common in most structured finance transactions. Fitch gained comfort with a lack of such an opinion given that the owner is a non-operating company and Fitch's understanding of the lack of a concept of substantive consolidation under Bermuda law.
This rating is sensitive to the occurrence of a qualifying natural catastrophe event(s), AIG's election to reset the note's attachment levels, changes in the data quality, the counterparty rating of AIG and the rating or performance on the assets held in the collateral account.
If a qualifying covered event occurs that results in a loss of principal, Fitch will downgrade the note to reflect an effective default and issue a Recovery Rating.
As mentioned above, if the Updated Sensitivity Case Attachment Probability reaches the Maximum Sensitivity Case Attachment Probability of 3.06% for class 3-A and 6.18% for class 3-B (which are considerably higher than the Sensitivity Case Initial One-Year Attachment Probability of 1.56% and 3.68%), the implied rating on class 3-A would fall to 'B' and class 3-B would fall to 'B-'.
The escrow model may not reflect future methodology enhancements by RMS which may have an adverse or beneficial effect on the implied rating of the notes were such future methodology considered.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Insurance Link Securities' (August 2014);
--'Global Structured Finance Rating Criteria' (May 2013);
--'Counterparty Criteria for Structured Finance Transactions and Covered Bonds' (May 2013).
Applicable Criteria and Related Research:
Insurance-Linked Securities Methodology
Global Structured Finance Rating Criteria
Counterparty Criteria for Structured Finance and Covered Bonds