Swiss Re’s new Chief Financial Officer, David Cole, said high yields for insurance-linked securities [ILS], such as catastrophe bonds, may lure inexperienced buyers not prepared for the risks they carry.
“The fact that no major natural catastrophes have occurred over the last two or three years doesn’t guarantee losses won’t occur in the future,” Cole said in a telephone interview from Zurich. “Some people are chasing yield, and may accept risks that they are not prepared for. Some of the new capital that comes into the market may not be as experienced or able to create a diversified portfolio.”
Issuance of natural catastrophe bonds, or cat bonds, surged to a record $7.09 billion last year as investors sought instruments with higher returns, Swiss Re said in January. The market had $20.2 billion of outstanding cat bonds at the end of 2013, almost 20 percent greater than the previous year-end record set in 2007.
Some investors may have been “blinded” by the relatively high returns, said Cole, who took on his job as Swiss Re’s CFO May 1, following George Quinn. “We don’t expect those returns to continue at the levels that we’ve seen, simply because we have benefited from relatively benign loss experience,” he said. “Over time we expect that to revert to the mean.”
Holders of cat bonds are typically assuming the risk of a pre-defined disaster during the lifetime of their bonds. The bonds’ principal can be used to cover the damage caused if the catastrophe is severe enough, meaning bondholders can face a loss of their investment.
“We can clearly imagine a situation where under a significant loss event investors in some of these alternative capital structures will lose money,” Cole said.