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Will Canada be next for catastrophe bonds?


The remarks made by the head of the top financial services and insurance regulator in Canada, which called for insurers to look to catastrophe bonds as an alternative way to access risk transfer and reinsurance capital, have sparked some speculation on when we’ll see a cat bond covering solely Canadian perils.

So far the catastrophe bond market has seen a number of rated, 144a cat bond issuances which have included Canadian perils. We’ve seen a number of indemnity transactions covering multiple perils, indemnity covering Canadian earthquake, modelled loss and also industry loss index triggers, but always within a cat bond containing risks from the U.S. as well.

To date no issuer, insurer or reinsurer, has stepped forwards to be the first to issue a solely Canadian risk cat bond, but the market’s appetite for new perils and geographic regions suggests that the time is right and investors are more than ready to support such deals.

Recent loss experience in Canada, particularly from flooding, alongside a realisation that cat bonds and insurance-linked securities now offer cost-effective alternatives, or complements, to traditional reinsurance programs have also raised the profile of the risk transfer instruments.

Julie Dickson, head of the Office of the Superintendent of Financial Institutions Canada (OSFI), said in a speech recently; “Given that catastrophic risk seems to be growing, going forward we may also see insurers more actively expanding risk transfer mechanisms through Insurance Linked Securities (ILS). Catastrophe bonds can be used to help companies to reduce exposure to certain risks, including earthquakes. Cat bonds are an effective way to transfer risk to capital markets, instead of reinsurance markets, and to spread risks.”

Dickson also discussed issues such as basis risk, stressing that cat bonds and ILS do not eliminate catastrophic risks entirely, but she suggested that they are a good addition to the protection insurers have in place, saying; “Such catastrophe bonds can be a good addition to an insurer’s risk management program.”

These comments have been picked up widely by the press, with the latest to cover them being Bloomberg. The publisher spoke to Shiv Kumar from Goldman Sachs who said; “I have not seen a deal in the catastrophe-bond market that is focused on purely Canadian risk. The market is very ready for it.”

Canadian cat bonds would make good diversifiers for investors, many of whom have had to reduce or completely stop taking on new capital in 2013 as despite strong issuance there haven’t been sufficient opportunities to deploy capital while maintaining diversity in their portfolios.

Any new region of the world to come to the cat bond market right now would be welcomed by investors. ILS managers suggest that they are ready to look at earthquake risk from new regions of the world and that other types of perils can also be looked at.

For investors the key is to have robust structures, transparent triggers and sufficient information to enable them to reach a level of comfort in the transaction. Once investors get comfortable with the deal they can properly assess whether to invest and how it would complement their portfolios.

So, for a cat bond featuring solely Canadian perils, there might be a little more work required up front for the first deal, but given the fact that Canadian risks have been included in cat bonds before it may not be as onerous as you’d expect.

Canada’s exposure to earthquakes, flooding, major storms and tornadoes means there is plenty of risk to consider packaging into a cat bond deal. Canada also has mature insurers that would be well suited to indemnity based cat bond transactions. Canada also has catastrophe loss data, available through Property Claim Services (PCS), a widely used provider of industry loss data for cat bonds in the U.S., so as a potential market for cat bonds it is well suited.

Kumar told Bloomberg; “There are a variety of risks that could be packaged by themselves or together with other perils and placed in the catastrophe bond market.”

Of course timing is everything and with catastrophe bond yields having declined so significantly this year, 2013 or early 2014 may be a very good time for potential sponsors of Canadian cat bonds to step forwards.

Kumar said; “Ten years ago it wouldn’t have made as much sense for them to come in this very exotic, very novel market when they could get pretty competitive rates in the reinsurance market. But the market has evolved so much that it is a very worthwhile proposition for Canadian insurers to explore.”

‘Where next’ is a regular topic of conversation in the cat bond market. Investors are keen to see the market expand, in a stable and sustainable manner. Sponsors, and potential sponsors, are keen to tap into alternative capacity from the capital markets for more than just peak perils in the U.S. and Europe. The will to expand the cat bond market into new territories, perils and lines of business is strong, but someone does have to be first and perhaps that could be Canada.

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