Climate change stimulates catastrophe bond market development: Fitch

In a new report, rating agency Fitch states that climate change is stimulating the development of the catastrophe bond market, as demand for protection rises and the capital markets offers an efficient source of reinsurance against climate-linked catastrophe events.

While the reinsurance market is facing challenges from macro-economic factors such as inflation, a persistent threat is that “weather-related catastrophe losses are likely to climb as the climate continues to change,” Fitch Ratings explained today.

Reinsurers are adding to their risk mitigation capability, to better manage the complexity and uncertainty surrounding climate change, Fitch says.

They are also re-assessing risk modelling and catastrophe management frameworks, as they look to quantify potential natural-hazard losses for underwriting, pricing and capital setting.

Of course, this also means a focus on retrocessional reinsurance and utilising third-party capital to manage catastrophe exposure and the uncertainty surrounding climate-linked events as well.

Because of this, Fitch Ratings says, “We expect the catastrophe bond market to continue to develop, given a rise in catastrophic events amid climate change.”

Continued market momentum for catastrophe bonds is forecast, in Asia which is where the report is focused.

But, the same goes for the rest of the world, where reinsurance firms and insurers are also grappling with the uncertainty and volatility of climate-linked loss events and seeking to shore up their protection against them.

“Demand for bonds issued via private placement by ILS is rising,” Fitch says, with regular capital infusions to the reinsurance sector via ILS instruments being seen in Asia now.

“Reinsurers are likely to face ongoing challenges in catastrophe-risk mitigation as climate volatility rises,” which the rating agency believes will continue to stimulate activity in catastrophe bonds, as one tool for re/insurers to mitigate climate risk exposure with.

While reinsurers in Asia are well-capitalised, Fitch sees them increasingly looking to the capital markets for reinsurance and retrocession support, especially to assist in managing climate risk exposure, it seems.

Of course, climate change is not the only stimulant of the insurance and reinsurance market’s desire to better protect and insulate itself against regular and severe natural peril losses, it is also recent loss history and the availability or cost of hedging alternatives, especially in retro markets.

But, as concerns over climates link to severe weather and natural peril industry losses increase, cat bonds are likely to be looked on as an efficient tool to secure capital markets capacity that can buffer against the financial effects of climate-linked disasters.

When Fitch talks about stimulating development of the catastrophe bond market, it really means in terms of use and volumes issued.

However, we strongly believe climate change will stimulate development of the market in a direction to provide better climate-linked ILS risk transfer solutions, as well as potentially longer-dated instruments that can also provide capital to protect against climate change onset.

At the core of the matter, capital markets backed risk transfer has a key role to play in supporting climate adaptation and mitigation efforts, so we expect risk transfer instruments will become embedded in the climate-response of countries and businesses around the globe.

The cat bond surely has a role to play here, in providing efficient risk capital to help financially protect against and absorb climate risk exposures.