Wall Street Journal: Bonds Prove to Be a Catastrophe

Nov 30, 2011

The following article was published in the Wall Street Journal on November 30, 2011:



First-Ever Securities to Cover Damage Exclusively From Severe Thunderstorms Are Poised to Default


The first bonds designed to cover damage exclusively from severe thunderstorms are about to become a total wipeout for investors.

Insurer Mariah Re Ltd. is poised to default on a $100 million, three-year bond that it issued in November 2010 on behalf of American Mutual Family Insurance Co., with bondholders expected to lose all of their principal.

Even in the realm of hurricanes and other natural disasters, defaults are rare. But for Mariah, at least, more are on the way. A similar batch of bonds for $100 million was issued in December 2010, and due to large losses also are in trouble.

A homeowner salvages items from his house, which was destroyed in the May 22 tornadoes in Joplin, Mo., where 159 people were killed.

A spokeswoman for American Mutual declined to comment.

It is a sign that the outlook for the market for “catastrophe bonds” is darkening after a brief recovery in 2009 and 2010. The sales of these bonds, which offer high yields because investors shoulder the risk of natural disasters, are on track to fall short of last year. Through September, $2.28 billion in natural catastrophe bonds have been sold, compared with $4.85 billion for all of 2010.

Bearing an annual interest rate of 6.25% in 2011 and earning investors about 7% since they were issued in November 2010, Mariah’s bonds appeared to offer a healthy premium over U.S. government debt. At that time, three-year Treasury notes were yielding just 0.392%.

While the coverage was targeted at damage from severe thunderstorms, these storms can be accompanied by hailstorms, tornadoes and windstorms that also are covered by the Mariah bonds over a 19-state territory.


Having exposure to tornadoes this year was ill-timed. The National Oceanic and Atmospheric Administration said 1,543 tornadoes have struck the U.S. this year, compared with 1,282 for all of 2010.

That boosted what insurers have to pay out and will cost investors all of their principal on Dec. 31, according to Standard & Poor’s Ratings Services. Investors had earned about $7 million in interest on the bonds since they were issued, according to Craig Bonder, managing director of New York-based Rochdale Securities.

For the first bond series, investors’ principal came on the hook for payouts once losses exceeded $825 million. S&P at the time assigned the bonds a B rating, slightly below the BB-category rating on most newly issued catastrophe bonds. Both ratings are below investment grade.

Bondholders were exposed to the devastation suffered by Joplin, Mo., in May, when 159 people were killed by tornadoes in one of the deadliest such storms in U.S. history.

While the default of the first-ever bond that exclusively covers thunderstorms drives home the inherent risk in these instruments, and the unpredictability of weather, Mr. Bonder said investors will continue to seek ways to boost returns. He said that while the Mariah bonds will be a near-total loss, other bonds are likely to perform better, leaving investors with positive returns overall if they have a diversified portfolio.

Total returns on catastrophe bonds through Oct. 31 were 1.4%, compared with a 9.9% return in the same period last year, according to an Aon Benfield insurance-linked securities index.

The Mariah-issued bonds were trading between 25 cents and 30 cents on the dollar early last week, Mr. Bonder said. As of Tuesday, they were being offered at between five cents and 10 cents on the dollar, but none were changing hands, he said.

For bonds rated by S&P, at least two other catastrophe bonds, for a combined $325 million, have defaulted in the past due to qualifying storms, and another four defaulted due to payment obligations that Lehman Brothers Holdings Inc. didn’t honor when it collapsed in 2008.

For the Mariah bonds, it was an adjustment of an estimate, rather than a new storm, that proved to be the tipping point. Last week, Property Claim Services, considered to be the final arbiter on insurance-industry losses, raised the losses attributed to “Catastrophe 42,” a storm that struck in early April, by $118 million, according to S&P. PCS decided that urban, as well as rural, areas in Kansas were affected by the storm, warranting higher payouts.

PCS declined to verify the loss figures citing the proprietary and confidential nature of its information.

Find this article at:  http://online.wsj.com/article/SB10001424052970203441704577068630752050256.html