Disaster insurance bonds are one of the few assets to make any money this year but new supply is on hold pending expected price rises in the underlying reinsurance market.
Market players say demand remains buoyant for the bonds, which transfer insurers’ financial losses from natural disasters to investment funds, for whom they offer high returns and low correlation with wider financial market risks.
So-called catastrophe bonds pay out, potentially costing investors all their principal, if a specified natural disaster occurs.
Up to $2 billion of new bonds are expected in the next few months, possibly before year-end, although hopes that 2008 would match last year’s record issuance are likely to be frustrated.
“We are busy structuring transactions that we hope will be in the market before year-end, and others … after the beginning of next year,” said Michael Halsband, a vice-president at Goldman Sachs in New York. “There continues to be a significant level of interest from sponsors who’ve been in this space before, and from new sponsors.”
Just $2.73 billion of bonds have been placed so far this year, against $7.3 billion in all of 2007, and there have been no new transactions since August.
But the bonds are one of the few financial assets still in positive territory as a year of unprecedented volatility nears its close. Swiss Re’s index of BB-rated catastrophe bonds has returned 7.96 percent since January 2007, compared with a loss of about 10.31 percent over the same period for similarly-rated corporate bonds.
UNCORRELATED
The market has even withstood a bout of forced selling, principally by hedge funds, after U.S. bank Lehman Brothers filed for bankruptcy on Sept. 15. There were plenty of ready buyers for the bonds, which kept prices relatively firm. “If ever there were a graphic illustration that, at least from an event point of view, catastrophe bonds are uncorrelated with credit, it’s been proven now,” said Mark Hvidsten, CEO of capital markets at insurance broker Willis.
“We’ve had a couple of billion dollars’ worth of paper happily absorbed into the remaining market and prices have remained strong. That’s absolutely amazing,” he said, adding: “The market has passed the first critical test of its existence with flying colours.”
Dealers say most catastrophe bonds are trading at above 90 percent of face value. About $1.5 billion of redemptions due before year-end — roughly 10 percent of outstanding catastrophe bond volume — and this reduction in supply should help underpin prices and new bond sales.
Planned new issuance is being complicated by a forecast turn in the underlying reinsurance market, where insurance companies have traditionally laid off their exposure to disasters.
With many contracts due for renewal on Jan. 1, insurers and reinsurers have said they expect rates to rise, reflecting 2009 catastrophe losses and investment writedowns that have eroded the capital they have on hand to underwrite risk.
That should encourage new catastrophe bond sales, although brokers warn little has yet been transacted at higher rates. “The industry can’t fathom where the market is in terms of reinsurance renewals, so we have a backed-up pipeline,” said Henry Kus, Head of Structured Insurance Products Trading at RBS.
“But it’s hard to see how rates wouldn’t harden (given current conditions)… Some effects take longer than others, but they must all have an impact.”
LOSSES
Insurers and reinsurers are still awaiting a definitive figure for losses from Hurricanes Ike and Gustav, which caused extensive damage in September.
Estimates vary, but risk modelling firm Risk Management Solutions said last month it expected Ike to cost the insurance industry between $13 billion and $21 billion, making it the third most costly U.S. hurricane.
The Atlantic storm season that ends on Nov. 30 has been the busiest since 2005, when storms including the $41 billion Hurricane Katrina helped push up reinsurance costs and boosted catastrophe bond issuance.
Losses on bond and share investments have also hit insurers and reinsurers’ balance sheets, further constraining their ability to underwrite risk, while dire market conditions have crimped their chances of raising additional cash.
“Issuance (of catastrophe bonds) typically picks up when reinsurance pricing hardens — that is when rates relative to risk are high — and we are entering that sort of market now,” said Erik Manning, a director within Deutsche Bank’s Structured Products and Alternative Risks group.
“I expect an increase in issuance, perhaps moderated by the general chaos in financial markets, which is having some effect on the investor base and on the capacity of capital markets.”
Another drag on new issuance is the downgrading to “junk” credit rating status of four catastrophe bonds guaranteed by a unit of Lehman Brothers, which raised concerns the market might be more vulnerable to the credit crisis than had been thought.
New bonds are likely to be structured to minimize such counterparty risk and ensure the collateral backing the bonds remains sufficient, market participants said.
“(The Lehman default) has caused a heightened awareness of this issue, and a determination to make sure credit issues can’t contaminate investments that are intended to be absolutely insurance-event-linked,” said Hvidsten at Willis.
(Editing by Chris Wickham)
Was this article valuable?
Here are more articles you may enjoy.
Two Montgomery Workers Charged with Insurance Fraud in Alabama 
Fla. Regulators’ Effort to Remove Insurer Execs May Not Pass Constitutional Muster 
Cracks in O’Hare Columns Aren’t Insured Property Damage, Just Bad Product – Court 
Insurer Chubb Readies $350M Payout Tied to Baltimore Bridge Collapse 
