Swiss Re Insurance-Linked Fund Management

Xactanalysis Insights and PCS

Catastrophe bond market shrinks further, becomes U.S. hurricane top heavy


It’s been apparent for some months that the catastrophe bond market stalled during the second quarter as a result of the impact of the Japanese earthquake and the uncertainty caused by changes to U.S. hurricane risk models. At the start of this year the market was feeling positive about the prospects for growth as the volume of catastrophe bonds issued were expected to outstrip the large amount of cat bonds maturing again.

The rest of the year is going to have to see some serious issuance now if we are to meet the goal of seeing the volume of risk capital outstanding in the cat bond market grow again during 2011. Cat bond maturities are continuing to wipe capital out of the market, with $2.4 billion scheduled to have matured during Q2, and investors have no new deals on the horizon to put that capital back into. This has led some to issue private cat bond transactions, such as Clariden Leu’s recent innovative transaction, purely to create opportunities for investors.

Investor demand remains high, in fact it seems as high as it’s ever been from our conversations with market participants. We’ve spoken to many investment sources who say there is a large amount of capital waiting to be deployed into cat bond or insurance-linked security transactions once the market comes back to life. So that’s positive for the rest of the year at least and hopefully will encourage potential issuers to take advantage of investor interest in the sector to bring deals to market.

So the cat bond market has shrunk further in the last quarter. Guy Carpenters 1st July renewals report which was published today (see our earlier article about their comments on the industry loss warranty market) discusses the Q2 catastrophe bond market.

$592m in new issuance came to market during Q2 through four transactions from Blue Fin Ltd., Johnston Re Ltd., Residential Reinsurance 2011 Ltd. and first time issuer Argo Re with Loma Re Ltd. Despite these four transactions and the record breaking first quarter of this year, the amount of risk capital outstanding in the cat bond market has shrunk to its lowest level since 2006.

The graph below, taken from Guy Carpenters report shows risk capital issued and risk capital outstanding from 1997 to 2011.

Catastrophe bond risk capital issued and outstanding

Catastrophe bond risk capital issued and outstanding - From GC Securities

So we hope that at the end of 2011 the trend is more for risk capital outstanding to be flat on last year rather than down. The potential is definitely there for the market to spring back to life after hurricane season and the capital exists to make deals happen, rather it will be down to the appetite of issuers which will depend to some extent on how the hurricane season pans out.

One other interesting point that Guy Carpenter raise is that fact that the catastrophe bond market is now extremely U.S. hurricane top heavy. This is a trend which has been happening since last year as diversifying opportunities have begun to shrink for investors. Guy Carpenter say that this has caused some investors to pull back on their allocation to U.S. hurricane exposure. The percentage of the cat bond market which is made up of U.S. hurricane risk has grown from 38% in 2003 to 71% today.

So, not only does the cat bond market need to see some issuance it needs to see issuance which does not include U.S. hurricane risk. Typically we would expect to see some diversifying cat bonds issued during late Q3 and Q4, particularly European windstorm and U.S. earthquake risks.

We hope potential issuers are taking note. Given the demand from investors, the fact the market has stalled and that diversification opportunities will be well received, this could be a great year to issue your first catastrophe bond so longs as it’s not a U.S. hurricane risk bond.

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