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Guy Carpenter: Catastrophe Bond Issuance May Climb in Fourth Quarter

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Posted on 13 Oct 2009

Insurers may issue more catastrophe bonds this quarter than the prior 12 months combined as investors settle for lower returns on the securities used to bet against disasters, reinsurance broker Guy Carpenter said.

Insurers may sell as much as $2.2 billion of the bonds in the fourth quarter, reaching $4 billion for the entire year, New York-based Guy Carpenter said today in a report. The last three months of 2008, the height of the financial crisis, were "silent" for new catastrophe bonds as buyers disappeared.

The market is recovering as yields relative to U.S. Treasuries narrowed this year, mirroring shrinking corporate bond spreads. The change makes insurers more willing to issue securities instead of buying backup protection from reinsurers. Buyers earlier this year had demanded 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.

Insurers “that were not inclined to issue during the first two quarters of 2009 because of pricing concerns may renew interest in catastrophe bonds,” Guy Carpenter said. “The general easing of prevailing yields across assets that are often compared to cat bonds should make it easier for insurance-linked securities investors to accept lower spreads while still generating competitive returns.”

Corporate bond yields this year fell 3.68 percentage points to 6.08 percent as of yesterday, according to Merrill Lynch & Co.’s U.S. Corporate & High Yield Master index. Corporate borrowers have sold more than $1 trillion in U.S. bonds in 2009, the fastest pace on record, taking advantage of lower rates and government support to bolster cash holdings after last year’s credit freeze.

‘Attractive to Issue’

The maturing of existing catastrophe bonds will fuel new issuance as insurers look to replace the expiring securities, said Peter Nakada, managing director of RiskMarkets at Risk Management Solutions Inc.

“There have been a number of catastrophe bonds maturing,” Nakada said in an interview. “Sponsors are optimistically looking at that market saying it should be fairly attractive to issue into the cat bond markets.”

A decline in hurricanes this year also prompted spreads to narrow and is adding to investor and issuer interest, said Guy Carpenter, a unit of insurance broker Marsh & McLennan Cos. Tropical Storm Claudette was the only system to strike the U.S. since hurricane season that began June 1. By this time in 2008, hurricanes Ike and Gustav had caused the majority of the year’s $25.2 billion in insured catastrophe losses.

Lehman Brothers

The Swiss Re Cat Bond Price Return Index rose 0.2 percent to 93.93 on Oct. 2. The index has climbed for 13 straight weeks, the longest streak of weekly gains since 2002, when Swiss Re Capital Markets began tracking the data.

The index plunged at the end of 2008 after the collapse of Lehman Brothers Holdings Inc. left the investment bank unable to meet its commitments to guarantee minimum returns on assets held by the cat bonds. Issuers of the bonds have since agreed to invest the money raised by the sale of the bonds in higher-rated securities until the money is needed to pay either the bondholders or the insurer.

The group of catastrophe bond buyers has expanded beyond hedge funds and specialists to include investors such as pension funds and money managers, Nakada said. Several hedge-fund investors sold their bonds amid the financial crisis to gain access to capital, he said.

“Who’s taking their place now is more mainstream investors who have discovered that this is a truly uncorrelated asset class that has exceptional returns relative to the risk,” Nakada said.

In the first nine months of this year, insurers sold 11 catastrophe bonds valued at $1.79 billion, compared with 13 bonds for $2.69 billion in the same period a year earlier. A $660 million bond is scheduled to mature this quarter and a $518 million bond will mature in January, said Guy Carpenter.

Catastrophe bond issuance $7.6 billion in 2007, according to Paul Schultz, president of Aon Benfield Securities, a unit of insurance broker Aon Corp.


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