* Japan quake is first event for Montana Re bond
* Subsequent covered event this year could trigger payout
* Sharp price fall reflects risks
By Sarah Mortimer
LONDON, June 2 (Reuters) - A catastrophe bond issued by Montana Re has been activated by March 11’s earthquake in Japan, meaning a future qualifying event could trigger a payout on the bond and losses for investors, market sources said on Thursday.
The $60 million bond, issued last year, covers Bermudan reinsurer Flagstone Re against losses from U.S. windstorms and earthquakes, Japan wind and quake, and European wind events.
Calculation agent Risk Management Solutions (RMS) determined that the March 11 earthquake was an “activation event”, but investors will not lose money for now because of the way the bond is structured.
RMS said in a report on Thursday that a covered event had occurred with an event index value of $322.2 million, according to investors.
Catastrophe bonds are used by the insurance industry to transfer extreme risks, such as those for earthquakes or hurricanes, to capital markets investors, who receive a yield in return for agreeing to cover damages they consider unlikely.
Topiary Capital, a catastrophe bond issued to cover Platinum Underwriters against losses from natural disasters, is similarly affected by the devastating March quake, although its investors have also remained unscathed so far.
Like Topiary Capital, the Montana Re 2010-1 Class E notes are structured as a second and subsequent event cover, which means the Japan earthquake alone could not trigger any losses to investors.
“The bond is now fully activated and will henceforth respond as a first event cover for the duration of the first annual risk period (through Dec. 31, 2011),” said one U.S.-based cat bond investor.
Assuming that no other qualifying event happens before Dec. 31, the Class E notes will reset back to a second event bond for the subsequent risk periods, until it matures in January 2014, said the investor.
Cat bond investors have priced in the Japanese quake as a first event for the Class E notes, the price of which has almost halved, according to brokers and investors.
One reinsurer is offering to buy the bond at 51.97 or sell it at 61.90, said one UK-based investor, with the fall in price from around par and 10 percent spread between the bid and offer prices indicating uncertainty about its future.
Only one catastrophe bond of 10 with a total value of $1.7 billion that were exposed to the quake has experienced a full loss as a result -- Muteki Limited, which was structured by Munich Re (MUVGn.DE) for Japanese carrier Zenkyoren. (Editing by Catherine Evans) (To join the Thomson Reuters Insurance Linked Securities Community for more news and analysis, click here)