Financial Times: Catastrophe bond offerings decline despite strong returns

Sep 8, 2008

The article below was published on August 29 in the Financial Times.  A downloadable copy is attached for your review.

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Catastrophe bond offerings decline despite strong returns
By Paul J. Davies

Published: August 29, 2008

Financial Times

Issuance of bonds linked to insurance risks has fallen dramatically in the first half of this year, but the performance of outstanding deals has bucked the broader trend of debt market problems since the credit turmoil hit last year.

Total returns for natural catastrophe bonds, the dominant form of insurance linked bond, have significantly outperformed corporate credit since the start of 2007, according to a new report from Standard & Poor’s.

The S&P calculations show that such debt has lived up to its sales pitch of being an investment uncorrelated with other asset classes, due to its performance being driven by more remote and non-financial risks, such as natural perils or demographic trends.

“The market has remained mostly detached from the disruptions seen in the credit markets,” the report says.

“We expect that the fundamentals driving risk pricing in [insurance linked securities] in general and nat cat bonds in particular will continue to protect this asset class from the worst of the disruptions being felt elsewhere in the traditional credit markets.”

However, issuance of these and other types of insurance bonds have fallen dramatically, with just over $2bn worth of deals sold in the first half of this year versus almost $12bn for 2007 and about $10bn for 2006, two of the biggest years for insurance linked security (ILS) issuance.

Much of this was to do with the spike in property and casualty premium rates in the aftermath of the devastating hurricane season of 2005, which included Hurricane Katrina, the storm that led to the flooding of New Orleans almost exactly three years ago.

As reinsurance rates have come down and balance sheets have strengthened since Katrina, Rita and Wilma all struck in 2005, the need to issue cat bonds has been reduced sharply.

Issuance of other kinds of ILS, meanwhile, have been hurt by the troubles at the bond insurers or monolines, which have been waylaid by their exposures to other forms of structured debt such as mortgage backed bonds.

Bonds from life insurers that aim to offload risks of unexpected or extreme demographic changes, or to raise cash now against future profits embedded in the book of current business, were usually given a higher credit rating through being wrapped, or guaranteed by a monoline.

S&P said that a market had not yet been established for unwrapped versions of such deals, which had held back issuance, although Barclays Capital recently sold such a bond on behalf of Aegon’s Scottish Equitable business, illustrating that it was possible.

Copyright The Financial Times Limited 2008


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