Death Bonds Drub Corporate Debt as Insurers Get Subprime Lift

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Death Bonds Drub Corporate Debt as Insurers Get Subprime Lift

By Oliver Suess

Jan. 16 (Bloomberg) -- Betting against a pandemic paid off for

Stahel, who earned returns on so-called ``death bonds'' that were

three times higher than those generated by corporate debt securities

last year.

``The kind of event needed to trigger an extreme mortality bond would

involve so many deaths that I'm not sure I would survive it myself,''

said Stahel, who manages 830 million Swiss francs ($759 million) of

insurance-linked holdings for Clariden Leu Alternative Investments in

Zurich. ``Neither 9/11 nor World War II would have triggered the

existing mortality bonds.''

Stahel said his death bonds gained 7.6 percent last year. An index of

corporate debt tracked by Merrill Lynch & Co. rose 2.5 percent in the

same period.

Mortality bonds pay as much as 5 percentage points over an

interest-rate benchmark such as the London interbank offered rate,

unless a pandemic or other event raises mortality rates in a given

population by a specified amount, such as 20 percent or more. If that

happens, interest and principal payments revert to the insurer to pay

claims. The securities are an offshoot of catastrophe bonds, which

investors have used since the 1990s to bet against hurricanes and

other natural disasters.

For companies such as Swiss Reinsurance Co., the world's largest

reinsurer, and Paris-based Axa SA, France's biggest insurer, selling

the bonds shifts some of their gravest risks to investors and protects

earnings in the event of a calamity.

Swiss Re

``Issuers of extreme mortality bonds are increasingly aware of the

potential impact of pandemics and the implications such events would

have on their balance sheets,'' said Hadfield, an analyst at

Standard & Poor's in London. ``We expect to see more extreme mortality

transactions in 2008.''

Swiss Re, which gets more than a third of its premiums from covering

life-insurance risks, sold the first mortality bond in 2003. The

Zurich-based company then transferred $705 million of

extreme-mortality risk a year ago to bond investors in a nine- part

sale of notes through Vita Capital III Ltd., the biggest offering of

such securities to date.

The amount of mortality bonds outstanding rose to $1.6 billion in 2007

from $762 million in 2006, according to New York- based reinsurance

brokerage Guy Carpenter, a unit of Marsh & McLennan Cos. Guy Carpenter

forecasts more growth this year as investors seek investments that are

uncorrelated with financial markets such as stocks and corporate bonds.

``Extreme mortality bonds are growing in importance for both insurers

and investors,'' Guy Carpenter said in a report published this month.

``A payout is extremely unlikely and expected only for pandemic,

widespread war or possibly terrorism on an unprecedented scale.''

`Flying Colors'

Death bonds and catastrophe bonds tied to natural disasters both

defied the collapse of subprime mortgages in the U.S.

Declines in the mortgage market led to losses and writedowns of more

than $100 billion for the world's biggest financial companies.

``The subprime crisis was a test for catastrophe bonds, and they

passed with flying colors,'' said Karsten Bromann, the Zurich-based

chief risk officer for hedge fund Solidum Partners AG. ``Last year

proved cat bonds aren't correlated with capital markets in general,''

said Bromann. His fund returned about 18 percent in 2007.

The only default on a catastrophe bond occurred after Hurricane

Katrina struck New Orleans in 2005, triggering $41 billion of

insurance claims. Property damages exceeded the threshold that

entitled Zurich Financial Services AG to keep investor funds from its

Kamp Re cat bond.

Spanish Flu

The market kept growing, with insurers selling a record $7.7 billion

of cat bonds in 2007, up 57 percent from 2006, according to Swiss Re.

The securities returned about 16 percent last year, a Swiss Re index

shows. A lull in big storms since 2005 is pushing down the cost of

reinsurance coverage and may lead to fewer cat bonds linked to

hurricanes this year.

``You had what insurance execs call a softening of the reinsurance

market,'' said Brynjolfsson, who holds $2 billion of

insurance-linked securities at Pacific Investment Management Co. in

Newport Beach, California. ``When that happens, cat bonds are unable

to pay high premiums.''

As for mortality bond, Swiss Re's latest issue is trading below face

value, a sign investors are wary of the risks, said Stahel of Clariden

Leu, a unit of Zurich-based Credit Suisse Group, Switzerland's

second-largest bank.

``Extreme mortality bonds are not really high on investors' minds

because the modeling is still opaque,'' he said. ``The last real

pandemic, the Spanish Flu, happened almost a century ago.''

Pandemic Costs

A moderate avian-flu outbreak among humans, similar to the 1957 and

1968 flu pandemics, could result in $31 billion in additional death

claims for the life insurance industry, according to the Insurance

Information Institute in New York. A severe pandemic like the Spanish

Flu, which killed as many as 50 million people worldwide in 1918 and

1919, may result in $133 billion additional life insurance claims.

Figures like that scare Nephila Capital Ltd., a Bermuda- based hedge

fund that oversees about $2.5 billion of insurance- linked securities.

It has yet to venture into mortality bonds.

``There's a growing life market, but we don't participate at all in

that segment,'' said Barney Schauble, a principal at Nephila.

``Extreme mortality is something we've looked at, but we continue to

see enough opportunity in our core markets.''

Munich Re, the world's second-biggest reinsurer, and Hannover Re have

both sold cat bonds. Both are holding off on death bonds.

Insurance-Linked Fund

Still, some investors are comfortable with the risks. Coriolis Capital

Ltd., a London-based hedge-fund company started in 2003 by former

managers at Societe Generale SA, bought its first mortality bonds a

year and a half ago and now has a fund dedicated to life-insurance

products.

``The recent participation of top investment banks such as Goldman

Sachs, Stanley, UBS and a few others is a good sign'' for

mortality bonds, said Diego Wauters, who worked at New York-based

American International Group Inc. and JP Chase & Co. before

founding Coriolis.

``Many funds that started as pure cat-bond funds are now changing

their rules to be able to invest in life securities to diversify their

portfolios,'' said Luca Albertini, head of European insurance-linked

securities at Swiss Re.

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