Allianz’s new catastrophe bond covers flooding in the UK by offsetting the risk against North American earthquakes, explains Marc Hannebert

ON 10 APRIL, ALLIANZ Global Corporate & Specialty closed a catastrophe bond for $150m. It transfers to investors the risk of severe river floods in the UK and earthquakes in Canada and the US, excluding California. Part of a $1bn programme that can be used to cover various perils, it is the first note issued by Blue Wings Ltd, a special purpose vehicle launched for the benefit of the corporate arm of the Allianz group.

Swiss Re fronted the transaction and also acted as arranger and lead manager. The securities have a Standard & Poor’s rating of “BB+”, and the insurance risk, modelled by Risk Management Solutions (RMS), is 0.54% per annum. The cover is fully collateralized with minimal credit exposure.

For the first time a cat bond covers flood risk to match the expectations of both the sponsor and investors. A sponsor never wants to disclose too much information on its actual portfolio, risk management, underwriting and claim processes. But this would normally be required with an indemnity trigger for the investors to be confident with the risk. For this reason a parametric trigger was more suitable. But the difficulty then was to create an index and post-event processes robust and transparent enough to satisfy investors, the rating agency and, at the same time, with limited basis risk for Allianz, the sponsor of the transaction.

Its architects then created what might be called a “virtual infrastructure” operated by Halcrow Group, a British engineering company. It enables the parties to know with adequate precision, the flood depths at more than 50 locations across the UK. Those depths are used in the index formulae which ultimately determine whether investors lose part of their investment.

Another remarkable first is that investors purchased a cat bond without having a precise historical value of the flood index. For all previous parametric transactions, risk analysis has included estimated values for historical events. Here, given the new infrastructure, that was not possible. Instead, investors relied on a prospective distribution curve of the index calculated by RMS using their as yet unchallenged UK flood model.