Swiss Re executes $40 million catastrophe risk CDO

Swiss Re Capital Markets Corporation (SRCMC) has executed what is believed to be the first ever synthetic CDO based on natural catastrophe risks. The underlying risk exposures were accessed through industry loss warranties (ILWs), for which Judith Klugman, a sales executive at SRCMC who worked on the deal, estimates issuance was $1 billion in 2001.

Similar to credit default swaps, industry loss warranties are derivatives that provide protection against large property and casualty insurance losses from natural catastrophes. ILWs are referenced to industry loss indexes that monitor property and casualty losses in different geographic regions – Florida, California and Texas, for example. To receive payouts on an ILW, the protection buyer is generally required to demonstrate some minimum level of actual loss – say, $10,000.

Catastrophe risk is attractive to the capital markets investors due to its low correlation with other risks on their portfolios. Klugman said the $40 million deal was a response to growing investor interest over the last year in adding catastrophe risk to portfolios. The CDO structure was selected, she said, for the leverage it provided.

"What we're finding is that our investors are allocating a lot more dollars to this sector," Klugman said. "Because of the limited supply to date fo cat bonds and the fact that a lot of investors who do have cat bonds are loathe to sell them [due to the short supply] we try to meet the demand on a derivatives basis for the same type of risk," she said.

The ILWs for the deal were facilitated by Willis Re, which acts as a broker in the ILW market.