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Home > Blogs > Anthony Harrington > Catastrophe bonds, part 2: The outlook for 2010

Catastrophe bonds, part 2: The outlook for 2010

Finance Blogger: Anthony Harrington Anthony Harrington

In Part 1 we looked at what makes catastrophe bonds an interesting investment option for a wide range of investors. The focus in Part 2 is on the prospects for cat bonds post the crash of 2008/2009.

The first thing to be said is that, while the cat bond market was rocked back on its heels by the recession, it did not go away. According to the likes of Swiss Re, one of the pioneers of cat bonds, although the first half of 2009 was extremely slow, it now looks likely that the volume of catastrophe bonds sold in 2009 will exceed $3 billion. This figure was helped by the fact that some 2008 cat bond issuances were pushed into 2009 by delays caused by jitters in the capital markets and it is helped too, by a flurry of late issues in the closing months of 2009.

The figure of $3 billion looks somewhat thin by comparison with the $7 billion worth of cat bond business written in 2007, but it has been viewed very positively by the markets—particularly since it exceeds the miserable $2.69 billion of business written in the whole of 2008. Cat bonds, the experts have concluded, have come through a real test of fire and have proved that they are here to stay.

One of the features of 2009, however, was a noticeable reduction in individual issue sizes, down to tens of millions rather than hundreds of millions. Another feature was the leap in premiums that issuers were having to offer in order to entice hedge funds, pension funds, and others back into the market. Some idea of just how much the crash flattened the market can be seen from the fact that, after a near geometrical increase in cat bond issuances year-on-year through to 2007, there were just 13 transactions completed in 2008. Of these only two took place after July 2008.

According to Reuters, the fact that the price of cat bonds (the premium paid by issuers to investors) had come down by as much as 3% or 300 basis points, by the end of 2009, plus the sharp increase in the number of bonds being offered in the closing months of 2009, heralds a potential bumper year for 2010.

Another factor that might help insurers offload risk to the capital markets via cat bonds is that, according to Swiss Re, 2009 was a very mild year for losses from catastrophes. Although the figures released by Swiss Re had still to take account of any potential losses in December, there were just $24 billion of insured losses globally, with $21 billion coming from natural catastrophes—a fraction of the $267 billion in losses recorded for 2008. Investors tend to brighten following a year of mild losses, and get a little gun-shy after a year of heavy losses.

The catastrophe bond market in Europe has also been given a boost by the launch in February 2009 of PERILS, a company set up by a group of insurers and reinsurers, including Swiss Re, Alliance, AXA, Munich Re, and Zurich Re, in order to aggregate and distribute reliable data on natural catastrophes across Europe. (See, for example, the Artemis blog on this theme).

Since the catastrophe modeling that underpins cat bonds (see Part 1) relies heavily on the modeling house having access to high-quality data, this is good news for potential Europe-related cat bond issuances. Anything that improves the prediction capabilities of catastrophe modeling naturally adds to investor confidence and makes it easier for issuers to get cat bonds away at reasonable prices. All in all, 2010 is shaping up to be an interesting year for insurers and investors alike.

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Tags: catastrophe bonds , derivatives , future prospects , insurance
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