By MATTHEW BRODSKY, senior editor/ Web editor of Risk & Insurance®
John Seo is as close to a rockstar in the catastrophe bond world as you're going to get. Co-founder of Fermat Capital Management LLC, one of the largest CAT bond investment funds out there, he is a charismatic top advocate for this unique type of insurance-linked security (ILS). He is also a kind of guy that will throw around the $1 trillion figure.
As in, institutional investors have $1 trillion that they want to invest in new asset classes, he claimed at a recent ILS meeting in New York. Not that all of that sizeable sum would go to just CAT bonds. But why not a chunk?
The consensus is that new issuances of catastrophe bonds could tally as much as $6 billion in 2010. If that turns out to be the case, that would be a very strong year, said Paul Schultz, president of Aon Benfield Securities, the banking arm of Chicago-based insurance broker Aon Corp.
E. Graham Clark, managing director at Citi, has even heard a figure as high as $7 billion.
"It's supposed to be big this year," he reported.
At $7 billion, indeed, that level of issuance would rival the best year the market ever had, back in 2007. Even at the lower end of the forecasted spectrum, ILS folks would consider it a success. Experts were even glowing about the $3.392 billion in issuance in 2009, a 25 percent increase over 2008, when the market all but broke after the collapse of Lehman Brothers, which had played a role in the business by setting up collateral arrangements.
There are several explanations for the current optimism.
"Catastrophe bonds have proven their worth," is how Pascal Karsenti put one explanation. The senior risk consultant at AIR Worldwide Corp., the Boston-based catastrophe modeler that's analyzed the underlying risks for most bond deals, said that the CAT bond market was one of the first to bounce back in 2009 after the financial meltdown. Investors took notice.
In the latter half of 2009, investors poured in. Gary Martucci, director at Standard & Poor's, estimated that as much as one-third of all 2009 issuances, based on the notional amount issued, happened at the end of November and in December.
For many of the issuances that seemed to be announced one on top of the other, they were oversubscribed. Issuers would initially say their bond was for $75 million, only to up it to, say, $125 million because of the eagerness of more than enough investors.
"At the end of the day, there's a lot of capital willing to be invested in CAT bonds," Karsenti said, adding that the manic activity of late last year should serve as the guide for what could happen in 2010.
Some of this investment money in new issuances will actually be recycled, said Schultz, as a number of old bonds are maturing in 2010.
Another big reason for new issuances is that CAT bond prices dropped in the second half of 2009, moving them down closer to traditional reinsurance. Catastrophe bonds typically are issued by reinsurers or even large primary insurers who are looking to transfer some of their long-tail catastrophe risk--one-in-100- or one in 250-year events--to the capital markets. They do it to minimize their credit risk amongst the usual cast of reinsurance or retrocessional characters. They do it because the payouts are mechanical and guaranteed with collateral. They do it as a strategic play, getting multiyear deals that protect their 10-Ks should Mother Nature perpetrate something massive, say, in California or Florida. They do so because they listen to the beat of their own drummer.
Generally, they do not issue CAT bonds because they are cheap. They are not cheap versus traditional reinsurance, and that's a reason why many (re)insurers stay away from issuing them.
And that's why you have oversubscription--more investment bucks for not enough issuances.
Perhaps, though, new issuers would come into the market if pricing got more in line with reinsurance prices, as it appears to be doing now?
As William Dubinsky, director of ILS at major market player Swiss Re, explained, both CAT bonds and (re)insurance each have some advantages in pricing risks. CAT bonds attract capital from the broader capital markets, which dwarf the size of the (re)insurance markets; yet (re)insurers can write many times the limit of their capital, whereas the capital markets only provide dollar-for-dollar limits. With respect to reinsurance for (re)insurers, the first point means that CAT bond pricing is often lower for certain peak or difficult to place perils. With respect to insurance for corporates, this second point means that insurers can usually offer a lower price on capacity.
Plus, the growth of CAT bonds is relative to what reinsurers do, and vice versa. If CAT bonds are cheaper and become more available, that will free up reinsurance capacity and make that available at cheaper prices, Dubinsky said.
Instead of calculating how much of that $1 trillion will come into the catastrophe bond market, the more sober-minded Dubinsky suggested that we consider the investor footprint across all ILS--not just in catastrophe bonds but in private deals and industry loss warranties, for instance. That broad perspective is indeed a positive one as well.
"We see them gathering the money and putting that money to work," Dubinsky said of investors.
March 1, 2010
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