Cat bond market making comeback; Many deals protect against hurricane losses

COLLEEN McCARTHY



An uptick in catastrophe bond issuance leading up to today's start of the Atlantic hurricane season is underscoring the strong demand for capacity for U.S. risks, experts say.

The catastrophe bond market—which has made a comeback following last year's financial collapse—has seen seven transactions close so far this year, bringing year-to-date issuance to $1.22 billion, with additional deals being marketed to investors (see box).

Experts estimate that total 2009 cat bond issuance will reach $3 billion.

The latest deal, a $250 million cat bond placed by San Antonio-based USAA Group, is one of three cat bonds that recently were increased in size due to investor demand.

Rising issuance of cat bonds ahead of the hurricane season is not unusual, experts say. However, the most recent transactions have a greater focus on U.S. perils and primarily feature coverage for U.S. hurricanes and earthquakes. One bond, East Lane III issued by Chubb Corp., provides protection against losses exclusively from Florida hurricanes.

In comparison, roughly $400 million of newly issued cat bonds in the first quarter of 2008 covered non-U.S. perils, including European windstorm, Japanese earthquake and other worldwide natural catastrophe risks, according to GC Securities, a New York-based affiliate of Guy Carpenter & Co. L.L.C. Observers say current market conditions, in part, are driving the demand for peril protection via cat bonds, including firming reinsurance rates and constricted reinsurance capacity for U.S. peak-zone perils.


``(Reinsurance) capacity is definitely tightening, and there is a concern about peak-zone exposures right now. For the large-capacity buyers, securitization is very appealing,'' said Edward Hochberg, executive vp at Towers Perrin's reinsurance unit in Philadelphia.

Meanwhile, buyers are not feeling as sharp a contraction for European catastrophe exposures, observers say.

``European wind has not had the same severity of loss as the U.S. wind, so there is a slightly more relaxed attitude about it,'' said Mark Hvidsten, executive managing director of Willis Capital Markets & Advisory in New York. In addition, ``capacity for European catastrophes seems to be holding up very well,'' he said.

The National Oceanic and Atmospheric Administration has projected that the U.S. hurricane season, beginning June 1, will be near-normal with nine to 14 named storms, four to seven of which may become hurricanes.

Despite the conservative forecast, ``it only takes one severe event to trigger losses, and cedents are looking for comfort that the money will be there when they need it,'' said Gary Martucci, director, financial institutions ratings at Standard & Poor's Corp. in New York.

But sponsors are paying more for the protection, largely because investors are demanding higher returns, experts say.

Insurers are paying as much as 50% higher than a year ago for cat bond coverage, said Jonathan Spry, senior vp at Guy Carpenter & Co. Ltd. in London. The difference in pricing between cat bonds and the traditional reinsurance market—which saw rate increases of 10% to 25% at April 1 renewals—has dampened the appetite of potential new sponsors, he said.

Others say pricing considerations likely will keep some cat bond issuers on the sidelines for now.

``I'm actually surprised that issuance has been as high as it has been, given the current pricing levels,'' said Mr. Hvidsten.

The majority of insurance companies that struck deals so far this year have been experienced market participants, including Swiss Re insurance Co., Chubb, Liberty Mutual Group Inc. and Allianz S.E. Though, New York-based Assurant Inc. made its first venture into the market last month by placing a $150 million cat bond transaction to protect against U.S. hurricanes for three years.

But not all observers are seeing a big difference in pricing between reinsurance and cat bonds.

Eric Brosius, senior vp and manager of reinsurance for Liberty Mutual Insurance Co. in Boston, said, ``I'm not seeing that there is a dramatic mismatch between cat bond pricing and traditional reinsurance pricing.''

``You have to understand that with cat bond pricing, you are attempting to price for three years vs. an annual reinsurance contract. And with a cat bond, you have a contract that is 100% collateralized up front.''

In March, Liberty Mutual placed Mystic Re II, a $225 million bond that provides three-year protection against losses from U.S. hurricanes and earthquakes.

``For us, the No. 1 reason to use cat bonds is to diversify our source of supply for a very important purchase. You can't put all your eggs in one basket,'' Mr. Brosius said.

Participants recently have returned to cat bonds after the market was restructured following a halt in issuance in the second half of 2008, when the collapse of Lehman Bros. resulted in downgrades on four cat bonds that effectively were guaranteed by the investment firm. The fallout raised investor fears about credit risk in a sector once touted as uncorrelated with the wider financial markets.


But the new cat bond structures featuring different trigger mechanisms, greater transparency and tighter collateral requirements have revived the market, easing both sponsor and investor fears, experts say (BI, March 30). While the pipeline remains strong for additional cat bonds this year, it will be a few more years before the market returns to the record nearly $7 billion in cat bonds issued in 2007, experts say.

Market experts say a variety of factors will continue to influence the market moving forward, including the severity of this year's hurricane season and the degree to which reinsurance prices harden.

Cat bonds issued in the next few months likely will trend toward buying protection for European perils, as European storms are largely a fourth-quarter event, experts say.

Munich Reinsurance Co. is marketing a $100 million cat bond, Ianus Capital, to provide cover against losses from European windstorms and Turkish earthquakes, market sources confirm. If successful, it will be the first catastrophe bond transaction this year based on a non-U.S. peril.