USAA: Catastrophe risking financing Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

USAA: Catastrophe Risking financing Case Solution

Overview of the case:

The catastrophe could affect the financial position of the companies and countries by affecting the physical and financial assets. The frequency of Catastrophe is expected to be low. However, the risk associated with Catastrophe is high. In order to mitigate the risk associated with Catastrophe, insurance companies issued Cat bonds, which are considered as the hedging instruments against the catastrophic event and the payoff upon these bonds depends on upon the occurrence of the catastrophic events. The management of the company is considering investing in CAT bonds in order to reduce the losses of $1bn or even more which could arise in the case of catastrophic events. However, the reinsurance policies of the cat bonds are still not clear, and the management is considering that whether this deal will be worthwhile for the USAA or not.

The structure of Class A-2 and Class A-1 securities

The structure of Class A-1 and Class A-2 security is different from standard securities, as Catastrophe bond involves additional risk capacity or entity which is termed as a special purpose vehicle and this special purpose vehicle acts as an institution who transfer catastrophic exposure to investors. Moreover, the structure of Class A-1 security is different from the structure of Class A-2 security as Class A security involves both principle variable and principle protected options whereas Class A-2 security involves only principle variable option.

Both securities have SPR, Residential-Re to write the reinsurance contract to provide reinsurance cover to Institutions.

In addition to this, there is also a difference in both securities with respect to the structure as there isa collateral account and counter party is involved in Class A-1 security in order to provide the contingent amount in case of the catastrophic event while there is no such collateral account in the Class A-2 structure. The Class A-1 security rated as AAA bond due to its protected facility and Class A-2 bond is rated as BB bond. Both securities have been categorized by the famous and reliable credit rating agencies such as S&P and Moody's.

Reason for introducing the Class A-1 securities

The Class A-1 and Class A-2 both are catastrophe bonds whereas, both bonds are slightly different from each other. However, the purpose of both bonds is to provide an additional contingent option to the insurance companies to reduce the risk that could arise in a catastrophic event. By viewing the structure of both securities, it is expected that the main reason behind the formation of the Class A-1 securities is to provide the facility of protected facility or contingent facility to the re insurers as there is no such facility in Class A-2 securities. Hence, the main reason of Class A-1 securities is to provide greater security to the short-term investors and this could also be the reason behind the AAA rating of Class A-1 bonds as the probability of catastrophic loss is low under this security.......................

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