The 'catastrophe bond' market is heading to a surprisingly healthy 2009
In an odd twist of logic, it's looking like a good year to be in the catastrophe business. The business of insuring against catastrophes, that is.
Industry insiders now expect that catastrophe bond activity will pass the $3 billion mark for 2009, which didn't really seem possible just did six months ago. Four more of these risk-transfer transactions are likely to be completed this month, Reuters reports, which would comfortably push the total to that mark. This comes after the market was bolstered by 2008 deals that were deferred to 2009 and a second quarter that was slower than usual.
Insurance and reinsurance companies use cat bonds as an alternative to traditional reinsurance and retrocession coverage (a tool that reinsurers use to pass risk along even further, like reinsurance for reinsurers), typically when those forms of risk transfer are too costly, require the assumption of too much counterparty credit risk, or don't align with broader risk-management thresholds or objectives.
Swiss Re's (SWCEY) Successor X was the 15th cat bond to be issued in 2009, and Scor's (SCRYY) $75 million cat bond, protecting its portfolio from Japanese earthquake and European windstorm risks, is expected to close in December. Swiss Re is pushing another transaction right now, for California earthquake protection, and Longpoint Re may involve up to five companies looking to transfer U.S. hurricane risk in the Northeast. Last year, only 13 transactions were completed, 11 of them in the first two quarters.
Put Off by the Financial Crisis
After 2007, the busiest year for cat bonds since the market began a decade earlier, insurers and reinsurers backed away from the tools, largely because of the financial crisis. Two robust quarters in 2008 were followed by a third quarter in which only two bonds were issued and silence through the rest of the year. The fourth quarter usually has brisk activity in cat bonds, because December tends to be the busiest month of the year.
Anxiety led many issuers to push their bonds to the first quarter of 2009 (first quarters are usually quite slow), providing a "false positive" at the beginning of the year, which was confirmed by anemic second and third quarters (relative to historical levels). Reaching the $3 billion threshold, while far short of 2007's $7 billion, would make 2009 one of the highest-volume years in this market and signal a return to normalcy. The fact that this amount could be reached even when property-catastrophe reinsurance rates are expected to decline at the Jan. 1, 2010 renewal certainly confirms the health of the market.
Michael Halsband, vice president on Goldman Sachs' (GS) financial institution structured desk, told Reuters: "To achieve a nearly $3 billion figure in issuance is a considerable success given the challenges the sector and the broader economic environment have faced in the last 24 months." He continued: "Considerable discipline has been brought to the market in 2009, as witnessed by the successful reintroduction of tighter collateral structures and greater transparency -- both key elements where the investors' and sponsors' interests are aligned."
Right now, the cat bond market is only $450 million shy of the $3 billion mark. Four recent transactions -- Multi Cat Mex ($290 million), Montana Re ($175 million), Vita Capital IV ($75 million) and Successor X ($150 million) -- brought 2009 issuance up to $2.55 billion. At the end of the third quarter, according to Guy Carpenter's (MMC) GC Capital Ideas, only $1.79 billion of these instruments had been issued.
In 2008, $2.69 billion in catastrophe bonds were brought to market, a decline of more than half from the year before. All but $320 million came in the first half, which was only slightly behind the 2007 pace. A typically quiet third quarter was stretched to the end of the year when Lehman Brothers and American International Group (AIG) fell into trouble on the same weekend in September. This led to concern as to whether the catastrophe bond market would be able to recover in 2009.
The return of stability in the credit markets made it easier for insurers and reinsurers to go to the capital markets for risk-transfer capacity, but pricing helped as well. In the first two quarters of 2009, cat bond spreads were at some of the highest levels ever seen, but this changed in the third quarter, and has persisted since. Halsband observes that cat bonds being issued this quarter have come down by as much as 300 basis points. This makes these tools more accessible to reinsurers, especially with the expected decline in reinsurance rates.
The increase in cat bonds issued and decrease in price signal a strong market for 2010, with plenty of opportunity for the likes of Swiss Re, Goldman Sachs and Aon (AOC), which are among the most aggressive investment banks in this space. Yet, the expectation of lower reinsurance rates could leave the insurance industry with less reason to turn to cat bonds next year.