Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Record $1 billion catastrophe bond issuance in Q1


Strong investor demand and attractive market conditions resulted in a record first quarter of 2011 for catastrophe bond issuance said Willis Capital Markets & Advisory (WCMA) in their recently published Q1 cat bond market report. $1 billion of catastrophe bonds were issued during Q1 2011 compared to $650m in the same quarter last year.

The first quarter has historically been fairly quiet, with not many cat bonds issued. The first three months of 2011 saw just four new cat bonds issued by regular market participants, however the demand from investors saw some upsize helping the total issuance reach $1 billion. All four of the deals (which you can read more on in our catastrophe bond Deal Directory) have some exposure to U.S. hurricane risks, The Hartfords $135m Foundation Re III issuance was solely a U.S. wind deal while the other three issuances were  multi-peril. Chubb returned to the market to issue the East Lane Re IV cat bond which was the largest deal of Q1, raising $475m.

WCMA point out that 72% of outstanding catastrophe bond limit is exposed to U.S. hurricane risks. With the hurricane season approaching that percentage is likely to rise during Q2. The concentration of cat bond risk in U.S. wind is something we discuss regularly with investment contacts, there is clear investor demand for more opportunities to diversify away from that risk and the market needs to broaden its scope more frequently to satisfy that demand.

No Q1 cat bond market report would be complete without a look at the earthquake in Japan and its effect on the cat bond market. WCMA hold the same view as the rest of the market that the Muteki Ltd. cat bond is a total loss and that none of the other exposed bonds will suffer any direct loss of principal. They suggest that Topiary Capital has been activated (again the market supports this suggestion), the $60m Class E notes of Montana Re 2010 are also exposed to second and subsequent events for the rest of this year. Swiss Re’s Vega Capital 2010 has a tranche which now has an increased risk profile as it has an aggregate attachment level which will have been eroded by losses from the Japanese quake.

The secondary market was traditionally slow in Q1, particularly due to the amount of cat bonds maturing in 2011. WCMA say there was some light trading as investors rebalanced or repositioned their portfolios. They expect secondary market trading to pick up in Q2 as issuance increases, activity in the primary market usually leads to secondary trading as investors make room for new investments and adjust their portfolios to keep the right balance of risk.

WCMA see significant investor demand to put assets to work in catastrophe bond form and they see this demand for risk in cat bond form maintaining some downward pressure on spreads. They say:

Furthermore, as significant catastrophe losses add up in 2011, potential sponsors may place more value on multi-year cover that provides a hedge against potential reinsurance price volatility if further catastrophe events occur.

The cat bond market could attract a greater share of capacity in the future, especially if meaningful progress can continue to be made on making the issuance process more efficient.

It’s not yet clear what effect the Japanese earthquake will have on cat bond pricing for new issues, say WCMA. However there is an opportunity in the situation the market finds itself which could lead to growth for the catastrophe bond sector.

The significant loss activity in the traditional reinsurance market creates an opportunity for cat bond investors to demonstrate that their capacity is provided by a pool of capital with a different cost and different investment  motivations to the traditional reinsurers. The ability of the market to provide consistent or expanded multi-year capacity at consistent risk spreads could stimulate new issuance and help to grow the market from the $12 billion in size it has been over the last three years.

We believe it is likely that cat bond pricing will continue to reference the pricing in the traditional market somewhat. In particular, we expect increased spreads for Japan earthquake risks. The other variable going into the second quarter is the impact of the new RMS model on U.S. wind pricing. The market was aware of the potential quantitative impact of the pending changes in Q4 2010; however, the actual release has created some surprises. As a result the full impact in both the primary market and secondary market remains unclear.

You can download the full report from Willis Capital Markets & Advisory here.

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