Cat bond market set for renewed growth
The catastrophe bond market emerged from the financial crisis at the end of 2009 as demand - in the form of investors seeking portfolio and risk diversification opportunities - on one hand met insurance and reinsurance company supply on the other.
Catastrophe or ‘cat’ bonds are high-yield financial products issued by insurance and reinsurance companies with a view to a specific natural catastrophe such as a hurricane, earthquake or tidal wave. If the catastrophe occurs, the bond holder loses all or part of its interest and in certain circumstances its principal, too.
Cat bonds allow insurance and reinsurance companies to mitigate their risks by redistributing potential losses to investors, and provide governments and businesses with access to hedging capacities greater than those offered by the traditional insurance market.
These bonds promise significant profits with a relatively low counterparty risk and yields which are not tied to traditional assets. In addition, the probability of the simultaneous occurrence of a financial crisis and a natural catastrophe is (now) reduced. At the end of 2009 the estimated volume of the cat bond market was USD 3.28 billion (CHF 3.38 billion). The SwissRe Cat Bond Performance Index (in USD) finished 2009 at 13.85% (as against 2.31% in 2008) while the US bond index offered a yield of 8.5% (1).
The cat bond market first took off in 1992 following Hurricane Andrew (USA) and has grown steadily ever since, reaching a record issuance volume of USD 7 billion (CHF 7.315 billion) in 2007. Following the collapse of both markets and counterparties in the autumn of 2008, it remained practically inactive until mid 2009 (2) .
Today, thanks to the existence of significantly more transparent product structures and sounder guarantee terms, it is possible to limit counterparty and credit risks with the linking of certain swap guarantees to government bonds (or government guarantees) or nationalised financial institutions (3). In addition, to monitor risks as closely as possible the new models used to evaluate cat bonds include climate development parameters based on the hypothesis that hurricane intensity is set to increase over the next 10 to 20 years (4).
It is interesting to note that the International Bank for Reconstruction and Development – a subsidiary of the World Bank – has set up MultiCat, a platform designed to help emerging nations issue this type of bond and thus increase their protection against the risks of natural disasters. The platform has already been tested, in particular by Mexico which has sold USD 290 million worth of cat bonds (5).
The cat bond market nevertheless remains extremely limited in terms of volume when compared to the bond market as a whole, but should gradually gain acceptance as a traditional investment form due to its attractive yield levels and the potential for risk diversification it offers (6).
In 2010 the market should see renewed growth. The general consensus of market operators (insurance and reinsurance companies, brokers, bankers and other specialists including risk analysts) is that market issuance should reach somewhere between USD 4 and 5 billion (7).
(1) Sarah Hills, "Swiss Re cat bond index finishes 2009 on all-time high," 14.01.2010, www.reuters.com
(2) Sarah Hills, "Catastrophe bond market emerges from crisis," 16.10.2009, www.reuters.com
(3) Christophe Fritsch, Julien Laplante, "Faire face à la tempête avec les obligations catastrophes," Investement Acumen: La revue de recherche d'Axa Investment managers, www.axa-im-structuredfinance.com
(4) Ibidem.
(5) "Catastrophes naturelles: une nouvelle plateforme d'émission d'obligations pour s'assurer contre les risques naturels", 28.10.2009, http://web.worldbank.org
(6) Sarah Hills, "Swiss Re cat bond index finishes 2009 on all-time high," 14.01.2010, www.reuters.com
(7) Sarah Hills, "Catastrophe bond market emerges from crisis," 16.10.2009, www.reuters.com