Here’s an interesting bit of news regarding MTA finances and a new bond issue: In what amounts to an essential hedge against future storm surges, the MTA has issued a $125 million “catastrophe” bond through its reinsurance broker that could cover some costs from a rainstorm or hurricane. Both Reuters and The Wall Street Journal have reported on the bond issue, and S&P assigned the bonds a BB- rating.
The bonds are unique in that they are a form of parametric insurance tied only to storm surge levels, and it is, according to S&P, a first-in-the-nation issuance. Essentially, the MTA would recoup the outstanding principal from the bonds in the event a named storm generates a storm surge of at least 8.5 feet in the Battery, Sandy Hook and the Rockaway Inlet or a 15.5-foot surge in the tidal gauge in the East Creek and at Kings Point.
The Journal notes that these bonds are “structured securities that allow insurers to transfer their own risks to capital-markets investors, instead of buying protection from more traditional insurance providers,” and Reuters notes that these are high-interest bonds that could carry significant risk for investors. The issuance details are available via Artemis, and the insurance news site offers up more analysis:
In this cat bond, MetroCat Re Ltd. will issue a single tranche of Series 2013-1 notes, which will be sold to collateralized a reinsurance agreement between itself and First Mutual Transportation Assurance Co. (FMTAC). FMTAC will receive from the cat bond a three-year source of per-occurrence reinsurance protection against storm surge measured during named storm events on a parametric trigger basis.
The single tranche of notes has a preliminary size of $125m we understand, although we’re told that the MTA could upsize this if pricing proves more attractive than other sources of reinsurance it utilises. The MTA’s motivation for issuing this cat bond is to expand and diversify its sources of reinsurance protection and also to obtain some coverage on a parametric basis which should payout more quickly than indemnity coverage.
The transaction features a parametric trigger based on actual recorded storm surge heights from a number of zones around New York city. A loss payment would be due based upon a parametric event index meeting or exceeding a trigger level for an applicable area, meaning that it may not necessarily directly correlate with the losses of the sponsor.
According to risk models, only Hurricane Donna in 1960 and Superstorm Sandy in 2012 would have triggered the principal payments and reinsurance provisions from these bonds. Market observers are intrigued by this new form of reinsurance, and analysts expect the MTA to ramp up use of such bonds if market response is positive and market conditions are favorable. In a sense, the MTA, which has not yet commented on these bonds, seems to feel that New York’s vulnerability to such surges from named storms will only continue to increase as the next three years elapse, and recovery money may be easier to access via these catastrophe bonds.
10 comments
Advertize the issuance in the climate change denier magazine.
Heh. A quatloo for you!
I cant make heads or tails of this post.
It’s just making investors perform the function of insurance providers. You buy into one of these, so long as no storm surge of the prescribed magnitude occurs, the MTA pays you and you get free cash. However, if a storm surge does occur, then you have to pay up just like an insurance company would.
As with all insurance, the risk calculation is in the insurers favor so they have a positive expected value for income. But due to the all or nothing nature of it it is still a risky investment by itself.
This is kind of like a derivative more than bond, if you’re familiar with those. Sort of like an option, instead of betting on a trading price, they’re betting on the weather, which is in fact not unheard of either.
(Well, I suppose a bond is technically a derivative too, but nobody really calls it as such.)
Lots of missing details on the deal. Including the duration of the bond and the duration of the insurance contract.
Hmm. The bonds are of unclear duration. The capital from the bonds is providing a source of reinsurance capital for “three years”… for a reinsurance contract of unknown duration.
The reinsurance is being taken out by First Mutual Transportation Assurance Co. (FMTAC). This is a captive insurer. This means that technically the MTA is buying insurance from it, but the MTA is also funding it; it doesn’t provide any real insurance, and is similar to self-insurance, but deals with the regulatory issues involved in stuff like workers’ comp. It is basically a regulatory arbitrage device, designed to deal with regulatory and tax issues in an advantageous way.
This means that the reinsurance it is getting is real insurance. The reinsurance issuer, however, is a special-purpose bond-funded vehicle.
It appears that this vehicle is issuing three-year bonds to fund its insurance operations. (Though the duration is actually unclear.)
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So, if you buy these bonds, and there is no catastrophe for 3 years, you get your money back plus 5% interest. If there is a catastrophe, you don’t get your money back, the MTA gets the money. VERY simple.
The late summer-fall hurricane season will probably affect the attractiveness of the bonds to some extent. A quiet season on the upper Atlantic Coast will probably help lure investors based on the relatively high interest rates BB- bonds would have, but anything close to a near miss (or at least something that can be hyped into a potential Sandy v2.0 by the local media) may make the sale problematic in the short-term, by convincing them the cycle of strong storms is changing for the worse.
Plan to Solve Global Warming:
– Sell a bunch of these bonds
– Investors suddenly become really interested in climate change.
– Profit
As a side note, this looks like a pretty sophisticated instrument for a government agency to be issuing. Who advises the MTA on these matters? Do they come up with ideas in-house, or do they outsource to someone else?
They certainly have financial experts on hand, but I would be surprised if they didn’t take advice from an investment bank or other underwriter that would be needed to help them issue the bonds. This really isn’t that complicated: they are buying a chance to get a payout if the sea reaches a certain level. That’s it. The hard part is calculating the risk of such an event. (It would, of course, be a pisser if loads of damage happened, but the storm surge was a few inches short of the cut-off.)
They’ve worked with more complex instruments in the past, like interest rate swaps. Not sure if I agree with the analysis entirely, but Nicole Gelinas actually does an okay job explaining the issue. And I think she’s right that it was pretty much a non-scandal. They made a smart bet that turned out to be wrong in hindsight.