The catastrophe bond sector has become an integral part of the broader risk transfer industry, and according to Cedric Drui, CFA, Managing Director at Neuberger Berman, the cat bond market will see continued growth for years to come.
In a recent podcast, Drui, alongside Sophie Ware, Senior Vice President at Neuberger Berman, discussed the outlook for the catastrophe bond market amid another record breaking year for the space.
“We do believe that cat bonds are not only here to stay, but see continued growth in many years to come,” said Drui.
He explained that despite clear expansion, when compared to the trillions of dollars of insurance capital that’s at risk, the cat bond market remains at roughly $30 billion in size, meaning that they still only represent a very small fraction of the global insurance marketplace.
“Overall, the current limitations of insurance coverage are still pretty high, which has a number of perverse effects, and leads to a large under-insured market,” he said.
As an example, Drui noted the lack of earthquake insurance take-up in California as a result of the cost of the underlying exposure, explaining how this also leads to an underserved market altogether.
In emerging economies, he continued, there are entire regions where the majority of people do not have the necessary protection.
“So, we believe that transferring some of the risk out to the global capital market is a very efficient use of capital, allowing the investors who are willing to take on that risk to have an interesting and largely uncorrelated return stream.”
Ware agreed that the market will continue to grow, explaining that this will not only be because of new cedents coming to market, but also as the industry sees traditional insurers and reinsurers look increasingly to the capital markets.
“While the capital market might seem small compared to other asset classes, the total ILS market size is now back at a record $97 billion, and some of this can definitely, potentially, be redirected into the capital market,” she said.
Currently, the cat bond market remains skewed towards U.S. wind risks, although other peril regions are increasingly coming to market as the risk landscape evolves.
Ware told the audience that her firm is seeing a lot of demand for regions and perils which diversify away from U.S. wind.
“So I think we’ll see more bonds covering Japan, Europe, Australia, and maybe even more developing countries; as well as, potentially, newer perils,” said Ware.
“So, the recent floods in Germany is an obvious example of a protection gap, and also, while it’s out of our universe, as we focus on natural-catastrophe events, cyber and other man-made perils are likely to be a big growth area.
“Generally the market growth is very positive for us as investors, as it allows increasingly diversified portfolios; but it’s also very helpful to create a liquid secondary market for the asset class,” she continued.
Another area of potential expansion for the market concerns the rise in responsible investing and the focus on ESG, which Ware feels is could be a strong growth area.
“For example, in the private-bond market, we’ve already seen a transaction from the Danish Red Cross, covering volcanic eruptions; so we know there’s a lot of potential demand out there.
“And another area of growth could be for specific ESG labelled cat bonds. For example, in June, we saw a €200 million issuance from Generali in Europe, marketed specifically as a green bond, in that the collateral be invested in assets defined as having a positive environmental impact,” said Ware.