Cat bond “structural evolution” means details matter: Klugman, Swiss Re

The evolution of the catastrophe bond structure and risk transfer product means that the devil is now in the details when it comes to providing price guidance to clients, making the job harder but the coverage more effective, Judith Klugman of Swiss Re recently said.

Speaking at the SIFMA Insurance and Risk Linked Securities conference held in Miami recently, Judith Klugman, Head of ILS Sales for reinsurance firm Swiss Re’s Alternative Capital Partners unit, discussed how the pricing dynamic has changed in the catastrophe bond market over the years.

“I always look at pricing from both the investor and the sponsor perspective,” she began, continuing, “I’m a firm believer that the cat bond pricing cycle can and will be different from the traditional reinsurance pricing cycle, they’re not necessarily meant to match each other.

“There are different dynamics on both and sometimes one product will be more expensive than the other. But from a risk management perspective, it’s great to have both thriving capacity sources.”

Klugman went on to stress that it’s not the case that ILS capacity always has to be cheaper, saying, “at certain times, one might be more expensive than the other and it’s not necessarily that cat bonds always have to be tighter and cheaper than traditional.”

However for many this is the ILS market they know, as in recent history, “It has been the case over the past few years because of overwhelming demand, that institutional demand.”

Klugman explained that in the early days of the catastrophe bond market it was a lot simpler to price transactions. But with the evolution of the structure and the reinsurance coverage that cat bonds provide, this has become increasingly technical and challenging.

“It’s fascinating on the pricing side. In the early days it was actually somewhat easier for me and my team to give price guidance.”

She explained that for a standard risk, such as a 1-in-100 Florida wind cat bond, the consensus on pricing was much stronger 10-years ago than it is today, making pricing, or at least providing guidance, an easier task.

“Now I think it’s interesting, especially with the evolution in the structures,” Klugman continued.

“We want to make this product work for the clients, so it needs to match their needs. There’s been a tremendous evolution from products in the early days, which probably had a significant amount of basis risk in them, to almost a convergence in the structures between a traditional reinsurance product and a cat bond product.

“But with that convergence comes a lot more complexity and that is why we also see the evolution of the investor base become a lot more sophisticated than they were earlier on, because of the complexity and also, investors now also have very different views of what the risk is.”

As a result the pricing of catastrophe bonds and the setting of price guidance is far more challenging and perhaps even more important than ever before, as its accuracy is key, given no-one wants to see guidance that is wildly out of line with final pricing.

Klugman said, “Pricing is somewhat of an art now, rather than like just an easy science and it’s an interesting dynamic as we evolve.

“The devil is in the detail, to think about what really is the structure, what is being modelled, how are these models being used. All that has to be taken into account when we think about the price. So it is very different now than it was back in the early days.”