A relatively soft reinsurance cycle has kept new issuers from taking the plunge into catastrophe bonds despite the return of stability to the market, industry watchers say.
The majority of catastrophe bonds are typically issued in the first half of the year — prior to the beginning of the North Atlantic Hurricane season — and this year only one new issuer was in the mix.
Of the 10 catastrophe bonds issued prior to June 1, only Lodestone Re — issued by AIG spinoff Chartis — is a first time sponsor. Lodestone, which covers Chartis U.S. windstorms and earthquakes was issued from Bermuda in May at $425 million.
The remaining nine bonds issued in the first half of the year are either extensions of expiring structures, or the return of issuers to the market after a brief respite.
Total issuance prior to the hurricane season is estimated at $2.35 billion, according to Reuters.
Some argue the lack of new issuers is not entirely unexpected. There are only two or three new sponsors of catastrophe bonds in any given year, says William Dubinsky, managing director and head of insurance-linked securities for Willis Capital Markets & Advisory.
However, Dubinsky points out that even though the amount of new issuers this year was typical, the appearance of Chartis as an issuer was significant.
“If you looked at the names of companies that have not done deals, Chartis was the most glaring omission,” he says. “They are an incredibly important buyer of reinsurance and one of the most savvy. The fact that they are in the market now builds confidence for other issuers.”
Chartis was created in 2009 and is the rebranded property/casualty unit of American International Group (AIG).
Significant numbers of new primary issuers will likely remain out of the cat bond market until reinsurance rates begin to rise and they find the capital markets on par with the private market, says John Brynjolfsson, CIO of Armored Wolf in Aliso Viejo, Calif.
“The market is relatively soft and there’s an ample supply of capital from reinsurance,” Brynjolfsson says. “The catastrophe bond market is there to provide tactical capital and allow issuers to enter the the market when it’s hard.”
Still, Brynjolfsson argues that the catastrophe bond market has made a remarkable recovery despite the lack of new faces. He says overall issuance is up by 100 percent over 2008, when the collapse of Lehman Brothers caused several bonds to default and halted new issuance for months.
“It’s a sign of a healthy market that those issues were resolved,” Brynjolfsson says. “Even if [2010 issuance ends up] below levels of 2007, it’s not an indictment at all. It’s a market that is growing in a disciplined manner.”
Active Hurricane Season Could Be the Market’s Real Test
Ironically, the key to enticing issuers and investors into the catastrophe bond market could be the upcoming hurricane season and the possibility of a triggering event.
The National Oceanic and Atmospheric Administration is predicting 23 named storms during the season that ends in November, with 8 to 14 storms strengthening into hurricanes. The NOAA further predicts three to seven of those storms could reach Category 3 status or higher.
Having a catastrophe bond trigger — and then pay out according to the bond terms — could strengthen the market’s confidence in the structures, according to Willis’ Dubinsky.
“These are sophisticated investors that are aware of the risks. If there is an event on par with 1906 San Francisco earthquake, investors would expect to lose a lot of money,” he says. “But if you get a tropical storm hitting Mobile, Alabama, and three bonds are triggered, you would lose a great deal of confidence.”
Brynjolfsson agrees, arguing that if the losses in cat bonds are seen as “real and proportional” to a triggering event, it could help ratify the concept of cat bonds in the eyes of ceding insures and investors.
He added that Kamp Re, the Zurich-sponsored cat bond triggered following Hurricane Katrina in 2005, helped build the market because it paid out according to expectations.
Recently it was also announced that Avalon Re — sponsored by Oil Casualty Insurance Ltd. — was moved into default after being triggered by losses from Hurricane Katrina.
For the remainder of the year, Dubinsky expects healthy issuance outside of North American windstorm risks. “For non-peak perils, the second half of the year would be brisk, based on pricing,” he says.
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