Catastrophe bond issuance last year reached the second-highest level on record, signalling a strong growth in the market, according to global insurance broker Willis Group Holdings.
Globally, $5.9 billion of catastrophe bonds had been issued as of the end of 2012, representing a 37% increase over 2011, according to the latest Insurance-Linked Securities (ILS) Market Update.
Insurers typically use cat bonds as an alternative to traditional catastrophe reinsurance cover.
Essentially, investors buy and hold cat bonds issued by an insurer for an established period of time. If no catastrophes occur during this period, the insurer pays out a coupon to investors, who make a healthy return. But if a catastrophe ‘triggers’ a bond payment during the specified period, the insurers use the investors’ funds to pay out the insurance claims.
Investors are basically gambling that a disaster will not happen during the period they hold the bonds.
Brokers have seen the catastrophe bond market expanded since its first introduction in the mid-1990s, following the Northbridge earthquake and Hurricane Andrew.
Canadian earthquake risk featured among 14 new cat bond issues during 2012 Q4. Lakeside Re III provided Zurich with $270 million of U.S. and Canada earthquake protection, on an annual aggregate ultimate net loss basis.
One twist on Zurich’s U.S./Canadian earthquake bond is the requirement for any covered earthquakes to have a shaking intensity of greater than Magnitude 6 within the covered territory. Coverage is further limited by a clause that establishes how many hours of ground shaking must occur before a payment is triggered.
U.S. hurricane risk continues to be the predominant catastrophic natural peril being securitized and sold in the capital markets – with 71% of outstanding cat bond limits exposed to some form of US hurricane risk.
“Given that the catastrophe bond market has a limited number of investors (relative to other asset classes), this naturally creates a significant concentration risk for investors,” commented Gary Martucci, a director with Standard and Poor’s Financial Services Ratings Group. “In response, issuers are coming to market with diversifying perils and exposures.
“If investors can achieve a high degree of comfort with the modeling for these other types of perils and pricing coming from these modeled results, investors certainly would be more inclined to allocate capital to these issues. An additional consideration has to be whether the insured value exposed to these non-traditional perils is material enough to make a securitization economically viable and attractive.”
