Insurers are issuing catastrophe bonds again to complement traditional and cheaper reinsurance and to spread the risks in buying protection against events that could cost them tens of billions of dollars in claims.
The nascent cat bond market froze for several months after the late 2008 collapse of investment bank Lehman Brothers, which had played a counterparty role in several of the early bonds.
But already this year 12 new cat bonds have been issued, transferring risks associated with natural disasters to capital market investors rather than traditional reinsurers.
A hurricane or earthquake can wipe out profits across the traditional insurance and reinsurance market, often driving up prices for cover and limiting the amount available for insuring against certain perils. Hurricane Katrina, the industry’s most costly natural disaster, cost $40 billion in claims.
“Cat bonds help to diversify our group protection capacity and supplement traditional reinsurance — especially for peak risk, such as European wind and U.S. perils like hurricane and quake,” said Georg Rindermann, senior project manager at Allianz.
Allianz is one of seven primary insurers that have issued cat bonds this year rather than relying solely on the reinsurance industry. The others are USAA, Assurant, Nationwide Mutual, State Farm, The Hartford and first time issuer Chartis.
Reinsurance companies, such as Munich Re and Swiss Re, also issue cat bonds to transfer major risks and thus free up capital to underwrite new business. They initially dominated issuance, but this year they have lagged primary insurers, issuing just five cat bonds so far.
Swiss Re issued two of these to cover against extreme mortality, Atlantic hurricane, European windstorm, California and Japan earthquake, while Munich Re issued the other three, against U.S. hurricane and European windstorm.
Catastrophe bonds are no longer seen as standalone transactions to cover peak natural perils, say market participants in the Insurance-Linked Securities (ILS) sector.
Just as a prudent corporation would not finance their company only from the banking sector, insurers are using the bonds to diversify their sourcing of reinsurance, said Chi Hum, global head of distribution at GC Securities, part of reinsurance broker Guy Carpenter. “From a risk management perspective, primary companies cannot afford to be exposed to the reinsurance cycle,” he said.
QUAKE AND WINDSTORM
The bonds also tie in the pricing for the duration of the maturity and protect the insurer against the reinsurance industry’s reaction to major loss events.
“There is … the risk that if a cat event were large enough, there could be a strain on the claims paying ability of some reinsurers,” said Gary Martucci, director at Standard & Poor’s Insurance Ratings.
Prices the reinsurance industry can charge primary insurers in premiums to cover their risks have not increased, but may do so after a significant natural catastrophe — for example, property and casualty reinsurance rates after Katrina in 2005.
Allianz issued the third bond in its catastrophe reinsurance program, Blue Fin Ltd, in May to protect itself against $150 million of U.S hurricane and European windstorm.
The reinsurance industry has already been exposed to extreme events this year — even before the start of the U.S. hurricane season on June 1, which is predicted to be more severe than average.
Private weather forecaster Commodity Weather Group raised its 2010 Atlantic hurricane forecast to 15 named storms, of which nine will become hurricanes and four become major category 3 or higher.
Loss claims such as those from the Chile quake, European windstorm Xynthia and flooding in Eastern Europe in the first half of the year are already above the long-term average, pressuring profits at a range of insurance companies.
Swiss Re and Munich Re both upped their Chile quake losses from initial estimates of claims. The Feb. 27 earthquake killed nearly 350 people and was the fifth-strongest since worldwide records began in 1900.
Access to the insurance-linked market has become a core strategy in supplementing traditional reinsurance, but cat bonds still need to prove their value over the market cycle, say insurers.
“Prices must be aligned between reinsurance and cat bonds, otherwise the market cannot evolve,” said Allianz’s Rindermann, saying the test will come when a sizeable cat event triggers a significant amount of bonds.
“The cat bond market must be reliable and available in both pre and post event situations; otherwise you cannot rely on it,” he said, adding that when this event does occur, new bonds would need to be issued and investors must be still available at prices that are comparable to reinsurance.
(Editing by Ruth Pitchford)