Catastrophe Bonds Remain “Niche” Unless New Perils Emerge, Costs Fall

The catastrophe bond market will be able to sustain up to $8 billion in annual volume, but it will find to nearly impossible to grow beyond that figure unless new issuers and new risks are introduced, according to a report issued by Fitch Ratings on Monday.

“[Fitch] believes that several structural issues inherent in the market will likely keep cat bonds as a niche asset class in the near term, supporting $5 billion to $8 billion of annual volume and up to $20 billion of outstanding issuances,” the report states.

According to Fitch, since much of the cat bond deal flow originates from limited number of large reinsurers that provide a steady stream of repeat issuances while the market does not take advantage of the many smaller insurers that find the structures too expensive. “For many smaller insurers, catastrophe bonds still remain expensive to issue relative to simpler traditional reinsurance, due to the number of parties involved in a financing transaction that significantly adds to the cost.”

In addition, the catastrophe bond market remains heavily weighted towards U.S. hurricane risk, with 73% of the market currently exposed to U.S. wind, compared with only 38% in 2003, Fitch explains. “In order for the market to grow beyond this level, it would need to expand beyond an opportunistic tool to a broader issuer base, such as with more corporate issuances, or potentially move into other coverage types such as business interruption and casualty lines.”

Interest in all forms of “alternative reinsurance” — including collateralized reinsurance, sidecars and hedge fund-backed vehicles — that seemed to dominate the current market cycles will likely wain over the next year as prices fall, Fitch argues.

“[To] the extent that hardening market conditions diminish into 2013, Fitch would expect less overall utilization of capital market reinsurance alternatives than has been the case in 2011/2012,” the report says.

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