SIFMA Conference: Catastrophe Bonds at an “Awkward Age”

Chris Westfall
Chris Westfall

Growth in catastrophe bond issuance is expected remain staid for 2009 and it will take at least three years before the market will reach levels of growth seen before the collapse of Lehman Brothers.

While industry professionals are confident the market will eventually return to the rapid growth levels seen earlier in the decade, they accept the market first will need to digest existing bonds and to win over investors burned by credit losses in the sector.

“The market is 13 years old and it’s at an awkward age” said Michael Millette, managing director of FIG structured finance at Goldman Sachs. “I see a market questioning itself but not imploding.”

Millette and other industry professionals made their comments at the Securities Industry and Financial Markets Association (SIFMA) Insurance & Risk Linked Securities Conference last week in New York.

Cat bond issuance will likely peak at $3 billion this year, nearly half the level of cat bond activity in 2007, according to Dan Ozizmir, managing director and head of insurance risk for Swiss Re Capital Markets.

Swiss Re estimates issuance will reach $5 billion 2010 and $7 billion in 2011. The market will have an estimated $15 billion in issuance in 2015, according to Swiss Re.

It will be a difficult adjustment for catastrophe bond professionals who have seen double-digit growth over the past several years, but losses on collateral programs have caused tremendous damage to the market, according to Millett.

“It’s not wonderful, especially given that we have not had a major [insurance] event,” Millett said. “It’s by amazing grace that the market has traded at equal levels during this period.”

For the market to rebound, it will first need to adopt new collateral programs to replace the failed total return swaps that caused credit losses on at least four cat bonds currently in the market.

That will take time, according to Swiss Re’s Ozizmir, citing estimates that issues redeeming at least 23 percent of the catastrophe bond market will have new collateral programs in place by the end of the year, 60 percent by the end of next year and 91 percent by 2011.

“There are significant differences between new and old structures,” said Ozizmir. “Everyone needs to take into account how long collateral issues will be in the market.”

Investors and issuers will remain skeptical for the near future as they use the traditional markets, which remain a cheaper alternative to cat bonds, said Robert Porter, CEO of Platinum Underwriters

“As an investor in cat bonds, there are other high yielding investments in the market,” Porter said. “As an issuer, there are industry loss warranties s and other, more accepted mechanisms for funding of cat exposures.”

Porter did say that the hardening reinsurance market will remain a wildcard for the cat bond market. If prices rise significantly during the upcoming renewal season issuers could find the capital markets a viable source of funding.

“This is especially true in the mid-year renewal season in the U.S. and whether there is adequate capacity.” Porter said. “I think there is a market for peak zone exposures, but for other perils insurers will be unwilling to pay the spreads.”

For many in the insurance-linked securities industry surviving the past several months of market turmoil means that the market could become strong and viable once again.

“We are certainly doing better than subprime,” Millette said.