Since its inception in 1996 the insurance-linked securities market has witnessed worldwide issuance of $38bn and has more than remained stable throughout the credit crunch. According to AM Best, the catastrophe bond market grew from $1.99bn to $4.69bn between 2005 and 2006, and Swiss Re predict that the wider ILS market will follow suit by growing to $1trln over the next decade.
Investors recently raced to buy a $260m catastrophe bond designed to protect East Japan Railway against earthquake damage. Rodrigo Araya of Moody’s Investors Service says, “The market has grown at a scorching pace in the last three years. We will probably see about $8bn in new issuance this year.”
At the end of August, catastrophe bonds returned 3.4 percent since May 31st according to data provided by Swiss Re, the world’s largest reinsurer and bigest underwriter of cat bonds. The average corporate bond declined 0.3 percent and asset-backed debt fell by 3.3 percent during the same period according to data provided by Merrill Lynch and Co.
The Financial Times reported Jacques Aigrain, CEO of Swiss Re, the world’s largest reinsurer and biggest underwriter of cat bonds as saying, “For the insurance-linked securities, what has been demonstrated is that there is absolutely no correlation between these type of risks and the financial market’s other assets”.
The introduction of Solvency II in 2012 will further encourage the market to grow. Solvency II is the most far-reaching change to the framework governing insurance companies in the European Union for over 20 years. Talking about Solvency II, Rick Watson who is managing Director of the European Securitisation Forum said, “The new legislation allows for insurance companies to use the transfer of risk onto the capital markets as a tool to reduce their regulatory capital requirements which was previously not permitted. This will encourage rapid growth in the sector as more risks are securitised”.
And we have this tidbit from Foreign Policy Magazine.
Your retirement savings may soon rest on a bet against Mother Nature. The reason? The rise of cat bonds. Short for “catastrophe bonds,” cat bonds transfer the financial risks that come with disasters such as hurricanes and earthquakes from insurance companies to the broader capital markets. Bruised by the stormy global economy, investment managers are flocking to these bonds in a bid to diversify away from assets linked too closely with suffering market trends, such as mortgage-backed securities. Even with climate scientists predicting more severe storms on the way, cat bonds are proving to be a gamble with plenty of willing takers.
How does a basic cat bond work? An insurance company sells a bond to investors who bet that, say, a hurricane won’t hit Miami and cause $1 billion in damages in the next year. If there is no hurricane, the investors get impressive payouts. But if the hurricane hits and the losses exceed $1 billion, the insurance company is off the hook and the investors are wiped out.
Growth in the cat-bond market has been swift. In the two years after Hurricane Katrina devastated New Orleans, the market for cat bonds roughly tripled to more than $13 billion. Goldman Sachs estimates the market will exceed $23 billion by the end of the year, and John Seo, a hedge fund manager at Fermat Capital Management, expects it to grow to at least $150 billion in the next 10 to 15 years.