Swiss Re Insurance-Linked Fund Management

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Catastrophe bond spread payments outstrip losses by 12-1


Zurich headquartered global reinsurance firm Swiss Re recently shared some interesting data on the ratio between catastrophe bond spread payments earned by investors and total losses to the investor base from cat bonds triggered by natural catastrophes.

According to Swiss Re’s Head of Non-Life Risk Transfer Martin Bisping, the way the catastrophe bond and insurance-linked security (ILS) asset class has performed in times of stress is one of the major draws for capital markets investors, with the ILS markets track record helping to generate significant demand for the asset class.

Bisping was speaking at a media event held at the reinsurers offices in London in November, at which he discussed the cat bond, ILS and alternative reinsurance capital market. Bisping said that the catastrophe loss history of the market helped to demonstrate the value investors can gain from an allocation to the cat bond market.

The cat bond market has proved resilient over the last decade, despite facing financial market turmoil and a number of major natural catastrophe events. Bisping was discussing the performance of the cat bond market, as measured by Swiss Re’s own Global Cat Bond Total Return Index, from 2002 to the present.

Over this near 11 year period, the cat bond market has delivered an annualised return of 8.56%, outstripping even high yield bonds, with an extremely low annualised weekly volatility of just 2.6% which is significantly lower than high yield bonds volatility of 6.58%. This shows the attractive performance of the asset class even through financial market uncertainty.

Cat bond high yield performance

Cat bond high yield performance
January 2002 – November 2013 - Source: Swiss Re

Perhaps more impressive is the fact that just 5 catastrophe bonds have been triggered by natural catastrophes over the course of this period, according to Swiss Re’s data. Within this period Swiss Re recorded roughly 230 cat bonds issued, consisting of around 440 classes of notes.

Over this period, from these 440 classes of cat bond notes, investors have received approximately $7.5 billion of interest spread payments, in return for taking on this risk. The total loss from the 5 triggered cat bonds was $650m, which means that the $7.5 billion of spread payments received by investors outstripped catastrophe losses by almost 12 to 1 over the period Swiss Re observed.

If we assumed a $150m average issuance size for the 230 deals in that period, we’d get to $35 billion of issuance. If you compare the ratio of the volume of cat bonds issued versus the losses you get a ratio of around 54 to 1. Again this shows the attractiveness of the space to investors, if for every 54 dollars issued just 1 dollar was lost.

Of course the spread payments and losses will have been shared among the ILS and cat bond investor community, with some investors receiving (and being responsible for) much larger amounts of each loss than others. The ratio is attractive though and shows another reason investors are increasingly drawn to the space.

Bisping highlighted that the majority of catastrophe bonds are structured for the most severe of natural catastrophe events, which fortuitously did not occur.

As cat bonds begin to take a share of the lower, working, layers of reinsurance programs, we should perhaps expect the number and amount of losses to increase. This is to be expected if cat bond investors want to take on risk with a higher expected loss (and higher returns) and as long as investment managers and cat bond bookrunners are ensuring investors are aware of the risk, and that they feel compensated for taking it on, then this should not be a problem.

It’s worth noting that four additional cat bonds were triggered during the period observed by Swiss Re but these were all due to the default of Lehman Brothers, so not included in the research undertaken.

Read our other articles on Swiss Re’s media event and latest Sigma report:

Alternative reinsurance capacity up by 80% since 2010: Swiss Re.

Catastrophe bond market reaches all-time high with 20% growth: Swiss Re.

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