LONDON (Reuters) - Bermuda insurer Oil Casualty Insurance Ltd. (OCIL) is offering to repurchase part of its Avalon Re catastrophe bond, a payout on which is close to being triggered, at a price equivalent to 80-85 cents on the dollar.

In a statement published on its website and dated August 6, Bermuda-based OCIL said it would buy back up to $50 million of Avalon Re Ltd.'s $135 million Class B variable rate notes due June 6, 2008.

The tender offer, which takes the form of a modified Dutch auction, will run until September 2. OCIL will pay between $800 and $850 for each $1,000 principal of notes tendered.

Goldman Sachs, which arranged the original bond sale, is dealer-manager for the tender. A Goldman spokesman declined to comment.

OCIL, which provides excess general liability insurance to energy companies, sold three $135 million tranches of bonds via Cayman Islands-based vehicle Avalon Re in 2005.

The deal was originally due to mature in June 2008, but has been extended in three-month increments since a July 2007 steam pipe explosion in New York pushed estimated losses to OCIL close to the level that would trigger a payout on the bond.

Credit rating agency Standard & Poor's has said it expects a principal loss on the Class C notes, which it downgraded in April 2008, citing the steam pipe explosion.

The rating agency said when the bonds were last extended in June that expected losses had not changed, but that claims relating to an oil spill and to lead paint exposure which could affect the Class B notes were still being monitored.

S&P estimates losses to Avalon Re of $147 million from 2005's devastating Hurricane Katrina, plus a further $150 million from a December 2005 explosion at Britain's Buncefield oil depot and up to $65 million from the steam pipe explosion.

Total losses of more than $300 million would trigger a payout to OCIL and losses for bondholders.

"Given these loss amounts, the Class C notes will likely incur a principal loss. The Class B notes, given the current status of the claims, do not appear to be at risk of a loss in principal," S&P said in June.

S&P said in a comment dated August 6 that it did not view OCIL's offer to buy back the bonds as a default, and repeated that it did not expect covered losses to reach the attachment level of the Class B notes.

"We consider this to be an opportunistic action because Avalon Re's ability to meet its obligations will not depend on the auction's success," S&P said, adding it expects Avalon Re to repay the principal in full at final maturity next June.

It suggested the discounted price OCIL is offering could reflect the low interest rate paid by the Class B notes relative to other bonds with the same CCC rating. Investors currently receive interest of three-month Libor plus 10 basis points.

The Class B notes had been trading at about 70-75 percent of face value prior to the tender offer.

If triggered, Avalon Re would be only the second catastrophe bond to pay out to its sponsoring insurer, following Kamp Re 2005, a $190 million deal triggered by Zurich Financial Services AG's losses from Hurricane Katrina.

Insurers have used catastrophe bonds since the 1990s to manage their exposure to natural disasters by transferring potential losses to investment funds. Investors receive a high rate of interest but risk losing part or all of their principal if a catastrophe occurs.