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Catastrophe Bonds Reach 2009 High on Storm Outlook

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Posted on 17 Aug 09

Catastrophe bonds, used by investors to bet against natural disasters, climbed to their highest level this year as hurricane outlooks called for a calmer season.

The Swiss Re Cat Bond Price Return Index advanced 0.3 percent to 90.56 on Aug. 14, the sixth straight weekly gain, as investors bet insurers are less likely to collect on the securities.

Insurers, including Chubb Corp. and Assurant Inc., sell the bonds as an alternative to reinsurance. If a disaster strikes, the insurer uses the money to pay claims and bond buyers face losing their investment. The National Oceanic and Atmospheric Administration revised its hurricane outlook this month to a near-normal to below-normal season. The bonds faced pressure in 2008 from the credit crisis and an above-average storm season.

“If you don’t have any hurricanes threatening the U.S., the investor base gets a lot more comfortable with owning these securities in hurricane season,” said Brett Houghton, a fixed- income trader at Rochdale Securities LLC. “There is the perception of reduced risk profile of the bonds.”

NOAA said Aug. 6 that the El Nino phenomenon, which produces warmer water in the eastern Pacific Ocean, is expected to reduce the severity of storms in the Atlantic. The agency had previously predicted a near-normal season.

Bill, Claudette

The Atlantic didn’t produce a named storm in 2009 until Ana on Aug. 15, the latest in more than two decades for the first storm of a calendar year to reach that intensity. By Aug. 15 last year, six named tropical storms had formed in the Atlantic. The Atlantic hurricane season lasts from June 1 to Nov. 30.

Hurricane Bill formed over the Atlantic Ocean, the first hurricane of the season, and the system is forecast to become a major hurricane, with winds of at least 111 mph, by Aug. 19, as it turns northwest on a course that may take it near Bermuda on Aug. 22, the National Hurricane Center said on its Web site. Tropical Storm Claudette weakened to a tropical depression and is moving over southern Alabama, the center said.

“We do expect less activity this year than we are used to,” said Jeff Masters, director of meteorology at Weather Underground Inc., in an interview last week. The 2008 storm season, in which Hurricane Ike slammed into Texas in September, was the worst since 2005 when Katrina struck the Gulf Coast.

Cat bonds are benefiting from investor confidence in credit markets, said Judy Klugman, managing director at Swiss Re Capital Markets, a unit of Swiss Reinsurance Co. and an investor in the securities. There has been about $1.8 billion in new issuance year-to-date, she said. Investments “accelerated over the past two months with the broader opening of the wider capital markets,” said Klugman, who is based in New York.

Lehman Brothers

Prices dropped in the nine months ended in May after money from cat bonds was invested in asset-backed securities and failed investment bank Lehman Brothers Holdings Inc. couldn’t meet commitments to compensate for declines in the holdings. Funds from newer cat bonds are more likely to be in government securities, said Houghton. The index is updated every week.

“Investors have taken a lot of comfort with the new structures because they are much more robust from a credit perspective relative to what the market standard was prior to the Lehman bankruptcy,” he said.

Buyers of cat bonds may earn as much as 17 percentage points above benchmark rates for taking the risk that a disaster could cost them their principal, according to Bloomberg data.

The cost has pushed some insurers to traditional reinsurance in which they share their premiums and risk with companies such as Munich Re and Warren Buffett’s Berkshire Hathaway Inc. FM Global, the Johnston, Rhode Island-based property-casualty carrier, decided not to issue new catastrophe bonds after having as much as $600 million in protection.

“We’ve gone to zero,” FM Global Chief Executive Officer Shivan Subramaniam said in an interview last week. “Cat bonds are more expensive than they were before.”

Source: Bloomberg


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