Swiss Re Insurance-Linked Fund Management

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Catastrophe bond indices show market was not concerned about Isaac


After a week dominated by hurricane Isaac’s potential impact on the reinsurance and catastrophe bond market, it’s timely that today we look at the secondary cat bond market indices to see if they give away any market nerves. It’s time for our regular look at the Swiss Re Cat Bond Performance Indices (our last article here) to see what they can tell us about movements in pricing and returns of outstanding catastrophe bonds and the general sentiment of the cat bond and insurance-linked securities marketplace.

Often when a major hurricane or other disaster threatens the cat bond market we see a pronounced dip in these cat bond indices as mark-to-market losses affect prices and investors seek to offload cat bonds with a potential exposure to get the risk off their books. This trend was extremely prominent as hurricane Irene approached the U.S. last year, as we reported here, but did last weeks hurricane Isaac have a similar effect?

There were a lot of catastrophe bonds which had exposure to losses in Louisiana and the surrounding Gulf Coast states, we detailed a number of them here. This shows the exposure that exists in the market to U.S. landfalling hurricanes, with over 70% of the market exposed to that risk, however the way cat bonds are structured means that the majority were safe from Isaac. Cat bonds are designed to protect sponsors against the most severe of catastrophe events and with Isaac not strengthening beyond Category 1 many cat bonds were out of harms way.

So now lets see whether the risk posed by Isaac had any negative effect on the cat bond indices, starting with the Swiss Re Global Cat Bond Performance Price Return index, which tracks the price return for all outstanding USD denominated cat bonds (which you can quote and chart through Bloomberg here). When we last looked this index had risen strongly during the start of August as the hurricane season had not threatened any impact and so cat bond price returns had risen more strongly than we’d normally expect at that time of year. So you would expect Isaac to have an impact? Well if there was any impact from Isaac it is not noticeable in the index, in fact the index has continued to climb very strongly through the remainder of August, closing at 94.23 on the 31st. Over the month of August the price return index has risen by more than 1%, a very strong month meaning that ILS fund managers will be reporting strong returns yet again.

Swiss Re Global Cat Bond Performance Price Return Index

Swiss Re Global Cat Bond Performance Price Return Index

So now we look at the Swiss Re Global Cat Bond Performance Total Return index, tracking the total return of a basket of natural catastrophe bonds (which you can quote and chart through Bloomberg here). As you’d expect given the strong performance from the price return index, the total return of the outstanding cat bond market has experienced similarly strong performance in the last fortnight. In fact, over the course of August this index has risen by more than 1.8% which once again underscores the incredible returns that cat bond market investors can make, even in the peak of the hurricane season. ILS fund managers will all be hoping for strong returns from August. This index closed on the 31st August at 232.82.

Swiss Re Global Cat Bond Performance Total Return Index

Swiss Re Global Cat Bond Performance Total Return Index

So there is no evidence of any impact from hurricane Isaac on these cat bond indices, showing that the market was not overly concerned about the storms approach. However some ILS fund managers have reported that they expect to see some mark-to-market impact from the storm, Credit Suisse being one of those. It is possible that they are referring to impacts to other types of insurance contract, so not cat bonds, or the expected mark-to-market impact to the Pelican Re cat bond which was the most exposed. The fact that Pelican Re was a smaller deal, at just $125m, and was unrated which suggests it was not as widely marketed as some other cat bond deals, likely means that any impact to it would not have a marked effect on the overall cat bond sector and only affect a small number of ILS fund managers.

This again shows the increasing maturity in the cat bond market and that investors are becoming much more aware when their portfolio is really at risk. Historically we have seen investors dumping positions at low prices as storms approach due to a nervousness over the potential impacts. Perhaps investors are becoming more familiar with models and forecasts or perhaps they are better diversified meaning they are happier to hold positions rather than sell.

It’s going to be interesting to see if these indices can continue their strong upward movement over the rest of the hurricane season. If they do, ILS fund managers could be looking at near record returns for these normally more risky months. Yet again it could be that demand is helping to keep the market bouyant at a time when it would usually be much slower. It will be interesting to hear ILS fund manager opinions on the market in August when they report later this month. We’ll update you in another fortnight.

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