Cat bond investors as good at paying claims as reinsurers: S&P

Despite being untested in the face of a major loss event and their relatively short existence, catastrophe bonds have a strong history of paying claims and the payment timeline is actually similar to that of traditional reinsurers, according to Standard & Poor’s (S&P).

International ratings agency S&P has released a report that explores the history and ability of claim payments from catastrophe bonds that have triggered, responding to concerns from reinsurers that cat bonds “can’t be relied upon in the same way that a relationship with a reinsurer can.”

Insurance-linked securities (ILS) capacity continues to enter the global reinsurance market, adding to the competitive landscape and contributing to the oversupply of capital. Catastrophe bonds, one of the dominant sub-sectors of the expanding ILS space, that has a current outstanding market size of roughly $25 billion, have had their ability to pay claims questioned by global reinsurers.

“As reinsurers try to defend their competitive positions from this relatively new source of capital, many have claimed that cat bond issuers haven’t established a track record of paying claims after major events.

“Others claim that the lack of a relationship between the protection buyer and the bond investors could encourage cat bond investors to contest legitimate claims following an event,” said S&P.

As a result of this, S&P notes that global reinsurers feel that buyers of protection should favour the traditional reinsurance industry’s practice and history of paying claims in order to maintain relationships.

However, research on 13 catastrophe bonds that have made claim payments following the occurrence of a triggering event, shows that catastrophe bonds actually have a short, but strong track record of claims payments.

“We have explored the claims payment history of cat bonds; in our view, the quality of the collateral and the pre-defined loss calculation offers protection buyers comfort that cat bond issuers are willing and able to pay claims. The timeliness of payments is similar to that of payments by traditional reinsurers,” explained S&P.

The longer-term protection offered by a catastrophe bond issuance supports a reduction of pricing uncertainty and, the fully collateralized nature of cat bond transactions ensures counterparty risk is minimal, says S&P.

This, combined with the fact that out of the 13 catastrophe bonds that have made claims payments identified by S&P, just one resulted in the loss payment being dragged out, by the reinsurer, shows the willingness and ability of cat bonds to pay claims in a timely manner.

“We consider that this payment history has actually strengthened cat bonds’ ability to pay claims. Cat bonds continue to provide a diversified source of protection to offload cat risk to the capital markets, and thus strengthen the industry’s ability to withstand losses following the next major event,” said S&P.

S&P notes that when compared to traditional reinsurance cat bonds actually have an advantage concerning willingness to pay, as the “wording of contract removes the issuer’s discretion regarding whether to pay claims; instead, the loss calculation procedures are set forth in the transaction documents and performed by third parties.”

Regarding the ability to pay claims, S&P explains that should adverse market conditions result in the quality of the assets to deteriorate, then the cat bond’s ability to pay would also deteriorate, as a bonds ability to pay claims relates “almost entirely on the quality of the assets in the collateral trust.”

The catastrophe bond market utilises a range of triggers to meet the needs of cedents, and as a result the timeline of claims payments can vary dependent on this. For example, a parametric trigger is structured to payout rapidly post-event, so it’s expected that bonds featuring a parametric trigger would payout faster than an indemnity-structured deal.

“The cat bond industry has grown rapidly over the past 20 years, and has withstood some of the worst catastrophe loss years on record, including 2004, 2005, and 2011.

“Although the cat bond market has not had a significant test of its claims paying ability, such as multiple bonds triggering in one year, there have been numerous triggering events around the globe over this period, and these have demonstrated the market’s strong claims paying track record,” concludes S&P.

Positive analysis of the catastrophe bond market from S&P and other industry observers is likely to increase market and investor comfort within the ILS space. Numerous discussions around the ability of cat bonds to pay claims and how the market will react after the next large loss event have circulated the industry since it really start to gain momentum.

In fact, S&P notes that in terms of disputes cat bond investors are no more likely to enter into one than a traditional reinsurance firm would be. Further evidence of this comes from the private ILS and collateralised reinsurance market, where claims are paid regularly and on the same terms as traditional reinsurance, as witnessed in the last few months of this year due to the increased catastrophe activity.

But the history of the marketplace speaks for itself, and so far, catastrophe bonds have shown to be a valuable and sophisticated asset class that demonstrates a strong track record of claims payments.

Below is a list of the catastrophe bonds that have made claims payments, as identified by S&P, and as recorded by the Artemis Deal Directory.

• George Town Re Ltd. which lost half a million due to catastrophe losses.
• Kelvin Ltd. which suffered a $5.1m loss due to cold weather (this was a weather-index cat bond).
• Kamp Re 2005 Ltd. which lost $145m on hurricane Katrina.
• Avalon Re Ltd. which lost $12.7m due to both natural and man-made losses.
• Crystal Credit Ltd. Class 2005-B which lost $39.1m & Class 2005-C Notes which lost $63m, both from trade credit claims.
• Nelson Re Ltd. (Series 2008-1), which ultimately did not end in a loss, but was impacted by hurricane Ike.
• Mariah Re Ltd. (Series 2010-1) and Mariah Re Ltd. (Series 2010-2), which were both total losses due to U.S. tornado activity.
• Muteki Ltd., which lost $300m due to the Tohoku earthquake in 2011.
• Vega Capital Ltd. (Series 2010-1) Class C which suffered a $16, reserve account erosion from the Tohoku earthquake and an aftershoch and Vega Capital Ltd. (Series 2010-1) Class D, which saw a $7m reserve account erosion from superstorm Sandy
• MultiCat Mexico Ltd. (Series 2012-1) Class C. which suffered a $50m or 50% loss due to hurricane Patricia.