SECTION: Section 3; Page 7; Column 3; Money and Business/Financial Desk

LENGTH: 810 words

HEADLINE: Investing;
Insurers May Turn to Catastrophe Bonds

BYLINE:  By ABBY SCHULTZ

BODY:
FACING huge losses from the Sept. 11 terrorist attacks, insurance companies needing protection against natural disasters are considering catastrophe-linked bonds, securities not known far beyond the circles of institutional investors and Wall Street.

The bonds usually cover specific disaster risks, like an earthquake in California or a hurricane in Florida. Such bonds are unlikely to cover terrorism, however, because the probability of a terrorist attack, unlike that of an earthquake, cannot be modeled by scientists, said Donald F. Thorpe, a director at Fitch, the financial rating company. But the bonds may fill a reinsurance gap caused by the attacks. Insurance companies often take out reinsurance to offset the costs of potential payouts. But with reinsurers paying large sums for losses related to Sept. 11, the cost of reinsurance is likely to rise and the amount of coverage issued by reinsurers is likely to fall, said John Kiernan, managing director for insurance products at Lehman Brothers.

As a result, it will be cheaper for insurance companies to issue catastrophe bonds than to buy comparable reinsurance, according to a Lehman report. Fitch said last week that more than $2 billion of catastrophe bonds were likely to be issued next year, double the typical amount.

Mr. Kiernan said the firm had three deals "in the pipeline."

And Michael J. Millette, a vice president for risk markets at Goldman, Sachs, said the "level of interest in issuing securities has increased materially" since Sept. 11.

Neither Goldman nor Lehman would reveal the names of the potential issuers. Under Securities and Exchange Commission rules, they said, the deals can be sold only to qualified institutional buyers, with minimum lots of as much as $250,000, and they cannot be advertised. Most catastrophe bonds have received ratings of BBB, a low investment-grade rating, or BB, a below-investment-grade rating, while some have been issued without ratings.

Officials at five insurance companies declined to comment on the bonds. P. J. Crowley, a spokesman for the Insurance Information Institute, which is financed by insurance companies, said the bonds were likely to supplement but not replace reinsurance. "I don't think this will be viewed as an immediate alternative to reinsurance," he said.

Some insurers like catastrophe bonds because the deals create a pool of money that can be tapped immediately in a disaster. First, an insurer creates a company to issue the bonds. The proceeds from the sale are put into a collateral account, which is invested in safe securities like United States Treasury bills and is used to make principal and interest payments to investors. Investors are insulated from the credit risk of the insurer, which in turn avoids adding debt to its balance sheet, said Mr. Thorpe at Fitch.

In the event of a disaster specified by the bonds, and if losses exceed an amount noted in the deal, the insurer can use the proceeds in the collateral account to cover its losses. Investors, therefore, risk losing all of their interest and principal payments if a disaster occurs, Mr. Thorpe said.
Of the 32 catastrophe bonds that have received ratings from at least one of the major agencies, none have lost interest or principal, he said. Investors in two early, unrated deals lost some of their principal, but high yields offset the losses, said Morton N. Lane, president of Lane Financial, a broker-dealer in Kenilworth, Ill.

To insurers, having a pool of readily available money may be more appealing than taking out a reinsurance policy, which is simply a promise to pay. "I pay you a premium and you promise to pay me if an event happens," Mr. Kiernan said. Insurers may be less comfortable today that a reinsurance company will be able to cover losses. "That was not that big a concern before Sept. 11," he said.

MANY existing catastrophe bonds were issued by reinsurers that provide insurance to other reinsurers. USAA, Munich Re and Swiss Re, for instance, have each issued several bonds.

USAA, based in San Antonio, is considered a pioneer in this area. It issued $150 million in three-year catastrophe bonds at the end of May, through Residential Reinsurance 2001, a special purpose corporation. The bonds, which protect USAA from losses to homeowners in a big hurricane over the next three years, were priced to yield 4.99 percentage points above the three-month London Interbank Offered Rate; the issue was trading on Thursday to yield 5.85 points over that rate on a seasonally adjusted basis, Lehman said. The total yield was 8.24 percent.

Yields on catastrophe-linked bonds have risen one percentage point, on average, since Sept. 11, but the bonds are no more risky today than before Sept. 11. "The risk of a big hurricane or big earthquake hasn't gone up," said Mr. Kiernan at Lehman.
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LOAD-DATE: October 21, 2001