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Swiss Re: Cat Bonds No Longer More Expensive than Traditional Reinsurance

Source: BestWire

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Posted on 12 Jul 2013 by Neilson

Cat bondsCatastrophe bond pricing has fallen by about 35% since last year, putting cat bonds on par with or perhaps even cheaper than traditional reinsurance for the first time, said Swiss Re, a market leader in the insurance linked securities market.

Sixteen years ago, the then-fledgling cat bond market began to grow even though cat bonds were more expensive than traditional reinsurance, Markus Schmutz, head of ILS structuring and origination for Swiss Re, said. "Initially people were interested in the additional features this product has over traditional reinsurance," Schmutz told BestWeek.

Cat bonds offer collateralized protection, which eliminates counterparty credit risk. Also, most cat bonds are typically three to five year contracts, which allow sponsors to lock in the coverage and pricing longer than they'd be able to under traditional single year reinsurance contracts.

"The early adopters in this market basically looked at this as a diversifying instrument," Schmutz said. However, the demand for ILS has grown so much that it's put pressure on the spreads, he said. Cat bond pricing has fallen by 30% to 35% in the last year "which has made it in many cases comparable or possibly even lower than the price of comparable reinsurance," Schmutz said.

The low-interest rate environment is driving investors to look for alternative investments, including cat bonds, he said. This increased demand from investors and issuers has teed up 2013 to be a record year for cat bonds, Schmutz said. About $8.2 billion in cat bonds were issued in 2007, the highwater mark for cat bonds issued in a single year, and 2013 could outpace that, Schmutz said.

Alternative capacity, including cat bonds, industry loss warranties and other collateralized reinsurance, is expected to grow to about 15% of the global property catastrophe market in 2013 up from about 8% in 2008, according to Guy Carpenter.

Thomas Holzheu, U.S. chief economist for Swiss Re, estimated the alternative capital in the market has grown to $35 billion or 10% to 15% of U.S. catastrophe capacity. "We expect...to see continued strong interest and growth in the alternative capacity and capital in the cat space," Holzheu told BestWeek. "At the same time, we need to remember that the exposure or the amount of cat risk that's out there and needs to be insured is growing at a clip that's faster than the economy [is growing]," he said. Catastrophe excess covers have grown 32% since 2009, he said.

Driving that growth is an increase in exposures, said Megan Linkin, a natural hazard expert with Swiss Re. She noted just one tornado loss exceeded $1 billion in insured losses before 1998. Since 1998, there have been 29 tornado/hail events with damage greater than $1 billion. In 2011, severe thunderstorms caused $25 billion in insured losses. "We're seeing areas that [were] previously hit by tornados when they were large agricultural fields, forests or undeveloped land. Now they are suburban developments," Linkin said.

About 67% of all cat bond capacity is still tied to U.S. wind risk, Swiss Re said. U.S. wind is also the largest risk in the traditional reinsurance market.

While Swiss Re expects the cat bond market to continue to grow, Schmutz said he doesn't believe it will ever take the place of traditional reinsurance. "Catastrophe bonds will always complement the traditional market, and sponsors will place a certain share of their [reinsurance] program into this market to get diversification," Schmutz said.

A dozen cat bonds with a total of $3.07 billion in capital were either pending or had already been issued this year as of May 7, compared with 16 cat bonds with a total of $3.46 billion issued for the first half of 2012, according to A.M. Best Co. data. The cat bonds issued by May include four new sponsors who joined the market this year: American Coastal Insurance Co., the Turkish Catastrophe Insurance Pool, North Carolina Joint Underwriting Association/Insurance Underwriting Association and Cincinnati Insurance Co. The Turkish Pool brought a new risk, Turkish earthquake, to the market for the first time.

"It's all about pricing," Asha Attoh-Okine, managing senior financial analyst of insurance-linked securities at A.M. Best Co. said in May. "These companies are trying to be very proactive, and look at where the best rate is. Is it a cat bond or traditional?"

2012 was marked as a banner year for cat bonds, as more catastrophe bonds were issued in 2012 than any other year except for 2007, a sign the 16-year-old marketplace is maturing. Cat bonds for property/casualty-related risks issued in 2012 totalled $5.9 billion, up from $4.3 billion the year before, and the second-highest ever behind the $7.4 billion issued in 2007, Attoh-Okine said.


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