Catastrophe bond issues expected to surge this quarter

Price drop said to spur interest in securities linked to insurance

Oct 25, 2009 @ 12:01 am

By Colleen McCarthy

The catastrophe bond market is poised for an active fourth quarter as several factors combine to boost the insurance-linked-securities sector, according to experts and observers. Insurers may issue $1.2 billion to $2.2 billion in new catastrophe bonds before yearend, an uptick that could result in a total of $3 billion to $4 billion this year, reinsurance intermediary Guy Carpenter & Co. LLC and its investment-banking arm, GC Securities Ltd., wrote in a recent report. Renewed interest by insurance companies in issuing the bonds is being driven in part by a significant drop in catastrophe bond pricing and investors' greater willingness to accept lower returns on the bonds, according to the report. The sector has had 11 transactions totaling $1.79 billion year-to-date, according to Guy Carpenter. John Seo, managing principal at Fermat Capital Management LLC, said that volume for the year could reach $4.3 billion. “We are really expecting this market to explode,” he said. “The capacity is there, and there is a willingness [by insurers] to issue.” By contrast, there was virtually no catastrophe bond activity in the fourth quarter of last year as the market reeled from the collapse of Lehman Brothers Holdings Inc. and the subsequent ratings downgrade of four such bonds backed by the investment bank. The market for catastrophe bonds issued in the next few months is expected to be dominated by insurance companies buying protection for U.S. wind and earthquake exposure, though observers said that some transactions will feature capacity for European windstorms and Japanese earthquakes.

Market sources said that two deals are being marketed to investors: one exclusively for California quake protection and the other for U.S. wind and quake exposure. The deals could be introduced this month, sources said.

Catastrophe bond pricing was high early this year, keeping many potential issuers on the sidelines, but it has softened since then.

“Insurers that were not inclined to issue during the first two quarters of 2009 because of pricing concerns” are likely to return to the market, Chi Hum, global head of distribution at GC Securities Ltd., said in a statement.

Catastrophe bond spreads, which determine the price for issuers, have tightened dramatically, resulting in lower prices, but some investors said that they don't expect prices to drop much more in the fourth quarter.

Recovery in the broader financial markets, which is increasing investor capacity, also is fueling the sector.

“There [are] currently more investors and more capital to put to work than we have had in a long time,” said Paul Schultz, president of Aon Capital Markets Inc.

The group of catastrophe bond investors is expanding beyond hedge funds and dedicated insurance-linked securities to pension funds and other institutional investors that have been “given the green light” to allocate a certain amount of money to the asset class, Mr. Seo said.

In addition, bonds totaling some $660 million are set to mature in the fourth quarter, with an additional $518 million in January. According to Guy Carpenter, this is expected to fuel the sector further.

A relatively quiet 2009 Atlantic hurricane season also has made catastrophe bonds attractive, observers said.

The latest deal — a $290 million catastrophe bond placed by the government of Mexico and backed by Swiss Reinsurance Co. — is one of three such bonds that increased their size due to strong investor demand. MultiCat Mexico 2009 Ltd. covers Mexico's natural-catastrophe fund and is expected to close this month.

In the third quarter, two deals closed. In July, Swiss Reinsurance America Corp. placed its $200 million Parkton Re Ltd. bond for hurricane losses in North Carolina and its barrier islands, and Hannover Reinsurance Co. placed a 150 million euro ($213.2 million) bond, Eurus II Ltd., covering windstorms in seven European countries.

Strong investor demand boosted both bonds past their original size, and pricing was much lower than expected.

Colleen McCarthy is an associate editor for sister publication Business Insurance.

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