Reinsurance Prices Falling as Catastrophe Bonds Take Off

Catastrophe (cat) bond pricing has fallen by about 35% since last year, putting cat bonds on par with or perhaps even cheaper than traditional reinsurance for the first time, said Swiss Re, a major participant in the insurance linked securities (ILS) market.

Markus Schmutz, head of ILS structuring and origination for Swiss Re, told
BestWeek
magazine that 16 years ago, the then-fledgling cat bond market began to grow even though cat bonds were more expensive than traditional reinsurance. “Initially people were interested in the additional features this product has over traditional reinsurance,” said Schmutz.

Cat bonds offer collateralised protection, which eliminates counterparty credit risk. Also, most cat bonds are typically three to five year contracts, which allow sponsors to lock in the coverage and pricing longer than they would be able to under traditional single year reinsurance contracts.

“The early adopters in this market basically looked at this as a diversifying instrument,” Schmutz commented. However, the demand for ILS has grown so much that it has put pressure on the spreads and cat bond pricing has fallen 30% – 35% in the last year “which has made it in many cases comparable or possibly even lower than the price of comparable reinsurance.”

The low-interest rate environment is driving investors to look for alternative investments, including cat bonds. The increased demand from investors and issuers means 2013 is on course to be a record year for cat bonds, overtaking 2007 when cat bond issuance peaked at about US$8.2bn.

BestWeek
also quoted Thomas Holzheu, US chief economist for Swiss Re, who estimated the alternative capital in the market has grown to US$35bn or 10% – 15% of US catastrophe capacity and predicted continued strong interest and growth in the alternative capacity and capital in the cat space.

“At the same time, we need to remember that the exposure or the amount of cat risk that’s out there and needs to be insured is growing at a clip that’s faster than the economy [is growing],” he said.

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