Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Catastrophe bonds out of favour, but still one of the best investments


Bloomberg is carrying another article discussing the current lack of interest in catastrophe bonds from an investment point of view. The current economic climate combined with the collapse of Lehman Brothers has caused a massive drop in investor confidence and reluctance among issuers to launch new deals.

A side effect of that and much discussed in the article is the drop in returns from catastrophe bonds from an investment perspective. The Swiss Re Cat Bond Return Index has declined 5% since the end of August, which for an investment that has historically had some of the highest interest rates seems a lot. Compare that with other investments (of the type that these investors may be interested in) such as treasury bills which have declined around 30% for the same period and it doesn’t seem so bad.

This is all fairly typical of any market in a time of uncertainty and upheaval. Investor confidence is low in pretty much any assets so for an exotic and complex instrument such as insurance linked securities to suffer is not surprising. For the instruments to be correlated to a major market slow down is also no surprise under the current economic climate, it’s a first for cat bonds as everyone thought they were non-correlated but that was always wishful thinking under extreme circumstances such as these. The default of Lehman and the impact on the four cat bonds in question is also not really that surprising, it had to happen one day, a market cannot be immune to defaults completely.

So, the current state of the market is actually not really surprising and shouldn’t be treated as such. Confidence will return and compared to other markets the catastrophe bond sector has fared pretty well given the underlying conditions. That said, lessons do need to be learned and ideas formulated to work towards minimising correlation with debt, finding ways to minimise the risk from issues with guarantors (such as Lehman’s) and looking into ways to make deals more transparent.

The market will bounce back, the pipeline is still filling up (according to sources) and appetite for catastrophe bonds will return once reinsurance rates rise and investor confidence returns (come on investors, the returns are still impressive!).

You can read the full Bloomberg article here.

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