LONDON, Feb 10 (Reuters) - A catastrophe bond sold by U.S. insurer Allstate Corp ALL.N is in default after special purpose vehicle Willow Re failed to make in full an interest payment that fell due last week.
The transaction is among four catastrophe bonds guaranteed by a unit of Lehman Brothers that were downgraded by credit rating agency Standard & Poor’s following the U.S. investment bank’s Sept. 15 bankruptcy filing.
Allstate confirmed late on Monday that Willow Re had not made the payment, due Feb. 2, within the five-day grace period.
“Last week, Willow Re paid approximately 91 percent of the interest due on the bond,” said spokeswoman Maria Gemskie.
“Allstate continues to meet its obligations under its reinsurance agreement with Willow Re. The default of Willow Re does not create any contractual obligations for Allstate.”
The $250 million bond, which matures in June 2010, was sold two years ago to provide Allstate, the largest publicly listed U.S. home and auto insurer, with protection against losses from windstorms in the northeastern United States.
S&P had already cut Willow Re’s Class B 2007-1 notes from CC to D -- its lowest rating -- on Jan. 30, saying the issuer had given notice it would not have sufficient funds to make the scheduled payment. It said assets held in the collateral account were not generating enough income to cover the interest due.
Willow Re and three similar deals used a unit of Lehman Brothers as total return swap counterparty, contracted to ensure the collateral backing the bonds was sufficient to meet interest and principal repayments, and to make up any shortfall.
When it collapsed, investors were left with direct exposure to market losses on assets held as collateral. S&P had said on Oct. 9 that it believed payments on Willow Re were at risk.
The default will not trigger a termination of the underlying reinsurance agreement between Allstate and Willow Re, meaning the bonds could still pay out to Allstate in the event of a severe windstorm in the northeastern United States. In that case, the exact payment received by the insurer would depend on the value of the collateral pool.
“What is expected to happen is that Allstate will continue to pay the premium required under the reinsurance agreement,” said S&P analyst Gary Martucci. “Willow will remit that money on a quarterly basis to noteholders, who will also get whatever comes in on the assets held in the collateral account.
“Currently the assets are performing, but are not generating sufficient cashflow to make the scheduled interest payments on the notes,” he said.
Insurers have used catastrophe bonds since the 1990s to manage their exposure to natural disasters by transferring potential losses to investment funds.
Investors receive a high rate of interest but risk losing part or all of their principal if a catastrophe occurs.
Only one such bond has ever paid out to an insurer -- the $190 million Kamp Re 2005, triggered by Zurich Financial Services AG's ZURN.VX losses from Hurricane Katrina, which devastated New Orleans in 2005. (Reporting by Catherine Evans in London and Lilla Zuill in New York; Editing by Sharon Lindores)
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