Catastrophe Bonds Risk Subprime Slice-Up, Swiss Re Says

April 30, 2015

Swiss Re, Europe’s second-biggest reinsurer, said regulators should prevent catastrophe bonds from being repackaged like subprime mortgages.

“It’s important for traditional players like us and regulators that we make sure we don’t get into a situation where you start having all sorts of packaging, repackaging, slicing and dicing and then risks ending up on balance sheets where they really shouldn’t be,” CFO David Cole said in a telephone interview Thursday from Zurich.

Hedge funds and pension firms have been piling into so- called insurance-linked securities. They include the $22.1 billion market for catastrophe bonds, where investors get above- market yields for taking on the risk that their capital could be wiped out by hurricanes, floods and earthquakes. The $575 billion reinsurance industry has typically sold the debt to help cover their most extreme risks from such disasters.

Sales of the bonds rose 12 percent in the first quarter from a year earlier to $1.84 billion, according to data compiled by Bloomberg Intelligence. Minimum issue size is typically $100 million.

“There may be some folks out there who think they can come in and out of the market almost like a day trader, but I would really caution them against that as it’s a market that is exposed to significant risks,” Cole said. “As a traditional reinsurer we have a very well-diversified portfolio, we know that we are going to absorb losses and we and our investors are prepared for that.”

Paying Out
Proceeds from selling the bonds are typically set aside as collateral and paid out if a pre-defined disaster strikes. So far, only a few catastrophe bonds have paid out, bringing losses for investors.

One of the bonds that caused a loss was the $300 million Muteki Ltd. cat bond issued in May 2008 by Munich Re, which sold the notes to help cover risks it took on from Zenkyoren, the National Mutual Insurance Federation of Agricultural Cooperatives of Japan. The payout was triggered by the 2011 earthquake in Japan, which caused a tsunami and made the Fukushima Dai-Ichi nuclear power station spew radiation.

As well as Swiss Re, managers, investors and issuers of the bonds include Aon Plc, Nephila Capital Ltd, Montpelier Re — the reinsurer purchased by Endurance Speciality Holdings Ltd. in March — and Bermuda-based firms Validus Holdings, RenaissanceRe and Everest Re. Validus said in January it raised more than $560 million from investors for funds that make insurance wagers such as AlphaCat ILS Funds.

Catastrophe bonds returned about 6 percent last year, according to the Swiss Re Cat Bond Total Return Index, which tracks dollar-denominated securities.

Alternative insurance capital, such as catastrophe bonds and collateralized reinsurance contracts, grew by 28 percent to $63.8 billion last year, according to Aon Benfield. That would keep alternative capital “on track” to reach $150 billion by the end of 2018, the broker estimated.

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