Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Catastrophe bond market proves resilient through testing 2011


This morning reinsurer Swiss Re held a media event at their London offices to provide invited members of relevant media with insight into the insurance-linked securities and catastrophe bond market over the course of 2011. The presentations began with a review of the last year and how the cat bond market coped with what Swiss Re termed a ‘testing year’. This is the first in a number of articles we’ll post to comment on interesting topics which were covered during the event.

Swiss Re’s Martin Bisping, Head of Non-Life Risk Transformation, gave a presentation looking at how the cat bond market fared during 2011. He said that the global cat bond market proved resilient despite facing significant challenges over the course of the year. A combination of large natural catastrophe events, model changes and volatility in the wider financial markets all conspired to make 2011 a particularly testing year for cat bonds.

2011 has been the second highest year ever for natural catastrophe losses according to Swiss Re sigma data which shows losses of over $100 billion, double the previous year and not that far behind 2005 when losses hit $123 billion. However despite this high incidence of catastrophe events and catastrophe severity cat bonds performed as expected.

The new U.S. hurricane model from RMS increased the expected losses for many cat bonds with U.S. wind exposure which slowed issuance of this peril at what is usually the peak time before the season began. However, issuance since the end of hurricane season during Q4 has been strong, including U.S. wind risks, showing that the market has come to terms with this although some deals have opted to use other risk models (we notice that there haven’t been any windstorm cat bonds which have used the RMS model since).

As if the catastrophic year wasn’t trying enough sovereign debt issues have also caused turmoil in the wider financial markets. However, that allows ILS and cat bonds to really demonstrate their strengths as an asset class and show the diversification and uncorrelated nature of the bonds.

So, despite all this turmoil that impacted the market 2011 has seen the highest ever Q1 volume of new cat bond issuances and the year as a whole looks set to be the fourth highest issuance on record. This clearly shows how the market has matured and learned to overcome obstacles which are put in its way, the testing year has also clearly demonstrated the value that sponsors can achieve from cat bonds and also the attractive returns that investors can hope to achieve. 2011 has seen the highest level of losses to outstanding cat bonds due to triggering catastrophe events ever, with losses and second event triggers activated by the Tohoku earthquake in March and the total loss of two Mariah Re tranches of notes due to the U.S. tornado season.

Cat bond issuance for 2011 is expected to be close to the volume issued during 2010, helped by a spike in European windstorm issuance in the second half of the year and high issuance in December, which again is impressive given the different issues that have affected issuance and the slowdown during Q2.

One are that Martin Bisping highlighted as underperforming within the market is the diversity of perils available. More issuance of diverse perils is required if the market is to be able to continue growing. U.S hurricane risks still dominate the market and while European windstorm issuance has grown issuance of other perils has shrunk in the last year. He suggested that we could see an increase in issuance of Japanese perils as a result of the losses faced from the earthquake and tsunami this year. This is a key issue that the cat bond market faces as opportunities for investors are limited by the lack of diversification in issued perils. With more diversification available through issuance of non-U.S. hurricane risks more investor inflows could be expected which in turn will help the market to grow.

Bisping’s presentation ended with a look at the year ahead and he said that the market is expected to grow in 2012 and we should see an increase in the volume of cat bonds outstanding (we covered this here last week). The fundamentals of the market are strong, said Bisping, and a strong issuance pipeline plus active secondary trading reflects stable appetite within the market. The size of the market will also be helped by new entrants of both investors and sponsors coming to market, something we are already seeing clear evidence of in the last few weeks.

Other factors which make the outlook for the cat bond market positive include the continued return of repeat sponsors to the market demonstrating their commitment to ILS, the robust forward pipeline particularly for U.S. hurricane risk and the impending Solvency II requirements which Swiss Re say could lead to increased issuance from European sponsors (more on Solvency II’s potential impacts here).

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