Swiss Re Insurance-Linked Fund Management

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How the Japanese earthquake impacted cat bond pricing spreads


The 11th March earthquake which struck Japan causing hundreds of billions of dollars worth of damage and killing tens of thousands of people also made an impact on the catastrophe bond market, particularly on the pricing spread between their bid and ask prices.

The devastating quake left a number of catastrophe bonds exposed to potential losses. Now that the dust has begun to settle somewhat we know that one transaction, Muteki Ltd., is likely to be a complete loss while other second-event cat bonds such as Montana Re Ltd. may be activated and so left exposed to one more qualifying event triggering it during the transaction lifetime.

The impact on the catastrophe bond market has been apparent in the decline experienced by the Swiss Re indices (our latest update on these) which have dropped by around 4% since the event and the lack of trading immediately after the event in the secondary market (now picking up again).

Insurance-linked securities investment manager Twelve Capital published a report yesterday featuring some insight into how the earthquake in Japan impacted spreads within the cat bond market. The report looks at how cat bond prices reacted as traders came to terms with the news that a loss was likely within the market.

The first chart below shows how the spreads of the catastrophe bond market as a whole responded to the earthquake. Twelve Capital point out that uncertainty around parametric index values used to trigger certain cat bonds essentially caused a halt in trading of those securities after the event. Overall, the chart below shows cat bond market spreads widening significantly after the earthquake up to the point where one impacted cat bond was understood to have defaulted (Muteki we assume), after which spreads started to come in again.

Catastrophe Bond Market Spreads after the Tohoku earthquake

Source: Twelve Analytics / CatEye

The second chart shows the pricing  and bid-ask spreads on three specific catastrophe bonds which are exposed to Japanese earthquake risks. The way the bid-ask spread widens and narrows demonstrates the way the market reacted for each bond. Midori, a parametric bond, spreads widened but came back quickly when it was understood that it was unlikely to suffer a loss. In contrast, Muteki’s price trended lower as its fate became clearer and then as it became understood that it was likely to default the spread tightened showing reduced uncertainty. The Montana Re Class E notes are likely to be activated, say Twelve Capital, and so the price for this bond dropped but the spread remained steady.

Individual Cat Bond Spreads after Japan Earthquake

Source: Twelve Analytics / CatEye

The eventual fate of these catastrophe bonds should be understood within a matter of weeks at which time the market will stabilise and we will be able to see the final impact of the Japanese earthquake on investors and the cat bond market reflected in the prices they trade at.

Register today for ILS Asia 2023, our next insurance-linked securities (ILS) market conference. Held in Singapore, July 13th, 2023.

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