S&P Assigns Ratings to Swiss Re’s ‘Successor Programme’ Notes

June 7, 2006

Standard & Poor’s Ratings Services has assigned its senior secured debt ratings to the principal at-risk variable-rate notes issued under Swiss Reinsurance Co.’s Successor shelf program (See previous areticle). “These are the first issuances under the seven newly established $1.5 billion principal at-risk variable-rate note programs,” said S&P

“The issuers are all special-purpose Cayman Islands-exempted companies whose ordinary shares are held in charitable trust,” S&P continued. “Within series, they issued various classes of notes and invested the proceeds in high-quality assets within separate collateral accounts for each issuer.

“The issuers swap the total return of the asset portfolio with Swiss Re
Financial Products Corp., in exchange for quarterly LIBOR [London Interbank Offering Rate]-based payments. Simultaneous to the issuance of the notes, each issuer entered into an ISDA-based counterparty contract comparable to a retrocession contract with Swiss Re. These contracts will provide Swiss Re with a source of protection for hurricanes in the North Atlantic, windstorms in Europe, and earthquakes in California and/or Japan on a per-occurrence basis over a period of up to two years.”

S&P also noted that “EQECAT Inc.’s proprietary models were used to determine the probability of attachment of each class within a series of notes. EQECAT will use information supplied by the designated reporting agencies to calculate a loss index (in the case of Successor Hurricane Industry Ltd., Successor Euro Wind Ltd., and
Successor Cal Quake Parametric Ltd.) or to model the losses to the corresponding notional portfolios (in the case of Successor Hurricane Modeled Ltd. and Successor Japan Quake Ltd.) following the occurrence of these natural catastrophes.

“The index or the modeled loss amount is used to determine whether or not a principal loss to the noteholders of that class of notes has occurred, and the amount of the loss. If a loss has occurred, assets in the collateral account are sold to fund the loss payment to Swiss Re, and the principal amount of the notes is reduced. The loss payments to Swiss Re will not necessarily bear any direct or indirect correlation to any loss actually incurred by Swiss Re.

“A significant part of the rating analysis took account of an assessment of the occurrence probabilities of the covered natural perils as modeled by EQECAT. Further, the ratings on the classes of notes are based on the creditworthiness of Swiss Re (long-term AA/Watch Neg; short-term A-1+) as payer of its obligations under the counterparty contracts and as guarantor of Swiss Re Financial Products, the counterparty for all total return swap contracts.”

However, S&P rated the notes significantly lower that “A”, between 6 and 8 notches, putting them in the “BB”, “BB-” and “B” range. They are higher risk investments than equity in Swiss Re. Even though there has yet to be a reported loss to investors on a Cat Bond, the rating agencies, notably S&P, have become more stringent in assigning ratings in the wake of the changes made by the cat modelers (AIR, EQECAT and RMS) in assessing catastrophic risk – particularly hurricanes (See IJ Website June 5 and 6, May 30 and 24).

S&P gave “greater weight” to EQECAT’s near term analysis in assigning the rating on the notes “in line with our newly published criteria” (see S&P’s “Updates U.S. hurricane Catastrophe Bond Ratings Criteria”, published on June 2, 2006 on RatingsDirect, at www.ratingsdirect.com – IJ Website June 5).

Explaining how a Cat Bond works, S&P said: “In general, noteholders lose money once the loss amount or the index value reaches or exceeds a predefined level, the attachment point.” However, in this case, “the class F notes issued by Successor Hurricane Industry have been structured as a ‘knock-out’ tranche. The holders of this class incur a loss only if the ultimate index value calculated by EQECAT remains between the attachment and a predefined upper limit, the exhaustion point. They do not incur a loss if the index value exceeds this exhaustion point.” S&P said it was the first time it has “observed this mechanism in relation to the issuance of principal at-risk notes.”

The rating agency also indicated that the “losses under the notes issued by Successor Hurricane Industry depend on industry losses published by Property Claims Services (PCS). If the PCS industry losses figures are reduced between payment dates, Swiss Re would be obliged to pay back parts of the loss payment already received from Successor Hurricane Industry. For the class F notes, this could result in a total repayment of principal by Swiss Re once the index value exceeds the exhaustion point for this class of notes.

“Swiss Re has the option to extend the maturity of each class of notes by four months. In addition, it is able to extend the maturity of the notes issued by Successor Hurricane Industry by up to 24 months to allow for the PCS industry losses to develop following a North Atlantic hurricane. During the extension periods, noteholders receive a lower coupon rate because the occurrence of any additional events during this time does not have any effect on the loss of principal.”

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