October 20, 2014 / 8:00 PM / 6 years ago

Extreme mortality bond testing investor view on pandemic risk

NEW YORK, Oct 20 (IFR) - An extreme mortality bond, which pays investors if a pandemic, a major terrorist attack or even a war causes more deaths than statisticians expect, is being quietly marketed to global institutional investors.

In these times of uncertainty, the trade for insurance firm AXA, the details of which are little known, will be a key test of whether investors remain willing to bet that the Ebola outbreak and geo-political tensions may not result in huge casualties.

Historically, there have only been a handful of extreme mortality bonds sold to investors by the largest mortality underwriters. These bonds, also called Mortality Catastrophe Bonds (MCBs), enable insurers to transfer extreme mortality risk to capital markets.

In such trades, investors buy notes with principal and interest payments exposed to the risk of an adverse mortality experience of a portfolio of lives. They can help an issuer - typically an insurance or reinsurance company - to offset large life insurance policy payouts if diseases such as Ebola, avian inuenza, SARS or AIDS start to cause extreme loss of life.

For investors, they can be a way to diversify a portfolio beyond US housing bonds or corporate debt holdings.

The AXA trade is expected to carry a similar structure, possibly with a few new additions, to previous trades by other issuers such as French insurer SCOR Global Life, which priced a US$180m trade in 2013.

The deal via Atlas IX Capital came in the form of a Double B rated Class B that had a term of five years and four months and paid interest of three-month Libor minus 6bp, plus a spread of 325bp.

Under the structure, Atlas deposited proceeds from notes issued to investors into a collateral account and then invested the whole amount in notes issued by the European Bank for Reconstruction and Development (EBRD), which paid Libor minus 6bp as coupon, according to a S&P presale report.

Investors in the notes were in turn paid coupons of around 3%-4% from the counterparty payments received and investment earnings on the collateral of insurance policies.

If a so-called mortality index value (MIV) exceeds a specified trigger level during a two-year measurement period, collateral is put to the EBRD at par to pay SCOR Global Life and the principal on the notes would be reduced accordingly.

If there were no triggers then the entire collateral would be put back at par to EBRD at the scheduled redemption date and principal on the notes would be paid back to investors.

“Companies bearing mortality risk obviously worry that in an extreme event, like a pandemic, they will have to pay out more than their mortality tables tell them they should expect,” said Stephen Rooney, a partner and co-head of Mayer Brown’s global insurance industry practice.

“One way for an insurer to hedge the adverse financial impact of a possible pandemic would be to issue extreme mortality bonds into the capital markets.”

On the flip side, if investors were faced with a rising pandemic, extreme mortality bonds could lose appeal or - at the least - become more expensive.


Despite all the nervousness around the Ebola outbreak, the bonds are expected to find a decent audience because the risk of a pandemic triggering a payout is seen as very low.

Axa’s 2006-era OSIRIS Capital bond included Ebola as a potential threat, but mention of the disease came with the caveat that a “major breakdown in public health systems would have to occur” before it would be considered a significant threat, according to a prospectus of the deal.

Depending on the bond, that can mean a 20%-40% uptick in mortality for a set region beyond what has been typical, said Ghalid Bagus, a principal and consulting actuary at Milliman Financial Risk Management, a firm that provides actuary analysis to major bond issuers in the sector.

“There are roughly 2.5m deaths in the US each year. If you have a 20% increase, that means about 500,000 extra deaths in the US,” he said. “You would need a large amount of extra deaths before principal losses occur on these bonds.”

In its stress test for the Atlas trade, S&P noted that its qualitative view took into account “the remote likelihood of a terrorism event, a tsunami, a nuclear detonation, a repeat of the 1918 pandemic in today’s environment, or a world war, all of which might counter the ongoing improvement in mortality rates over the past four decades.”

The advancements in preparedness for pandemic disasters are also expected to mitigate the impact of such an event on the population.

“So there is zero risk in doing this bond, right,” said one banker. “Because if it triggers, you are dead and your boss is dead. So that means zero risk.”

An AXA spokesman said the firm could not comment on this topic because the trade was in a 144A format.

This article first appeared in the Oct 17 edition of the International Financing Review, a Thomson Reuters publication Reporting by Shankar Ramakrishnan and Joy Wiltermuth; Editing by Anil Mayre

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