Chapter 20

Fixed Income Case Study, Swap Market: The Allstate Corporation

Algorithmics Software LLC*


Event Summary

On February 6, 2009, it was announced that a $250 million catastrophe (cat) bond, Willow Re, issued by Allstate in 2007 and backed by Lehman Brothers, had defaulted on an interest payment. Allstate Corporation was the ceding insurer of Willow Re—one of four cat bonds that had Lehman Brothers Special Financing Inc. listed as their counterparty in a total return swap. The swap was terminated due to the collapse of Lehman Brothers in September 2008. The bond, due to mature in 2010, was issued to cover potential exposure to storms in the northeastern United States.

Event Details

Catastrophe (cat) bonds are a type of insurance-linked security used to manage exposures to natural disasters. Investors in a catastrophe bond receive coupon payments, but can lose some or all of their principal if a specific type of natural disaster occurs in a particular region and claims are made. The bonds were first developed in the 1990s. Cat bonds became well known after Hurricane Katrina devastated New Orleans in 2005. The catastrophic hurricane led to payments totaling $190 million that were paid out by Kamp Re to cover claims against Zurich Financial Services. Kamp Re was the first catastrophe bond to suffer a publicly acknowledged total loss of principal, although there may have been earlier wipeouts that were not disclosed to the public.

Willow Re was issued ...

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