< Study Room | 08.05.2017 |

A-Z OF… CAT BONDS INCREASINGLY DOMESTICATED

A-Z OF… CAT BONDS INCREASINGLY DOMESTICATED

Darren Bailey takes an alphabetised look at the ever-more commonplace catastrophe bond

Despite their recent prominence, catastrophe bonds are far from being a new concept, having been first structured in the mid-1990s, following Hurricane Andrew in the US, as a way to bring additional capacity into the re/insurance market. The catastrophe bond sector has since achieved steady growth and has established itself as a proven risk transfer mechanism to move insurance, reinsurance, and even corporate risk into the global capital markets.

Cat bonds, as they are commonly known, act as a contract between the originator of a bond – known as the sponsor – and investors, such as pension funds, hedge funds and reinsurance funds. Sponsors of catastrophe bonds are mainly insurance and reinsurance companies.

In return for their investment, catastrophe bond investors receive a regular payment, known as a coupon, as well as the return of their original investment, known as the principal, when the bond reaches the end of its term, or ‘maturity’. The term of a catastrophe bond is generally three or four years, although five-year bonds have been launched.

While held in the bond, investors’ capital is exposed to pre-specified catastrophe risk, which includes natural perils such as hurricane, earthquake, windstorm and tornado. The catastrophe risk is often related to a specific country or region, such as Japan, Florida or areas of the EU.

RECORD BREAKING BONDS

The zenith of the catastrophe bond market occurred in 2016, when around $27bn of bonds were active in the marketplace. In terms of annual issuance, record levels were reached in 2014 when more than $8bn of bonds were launched, covering a range of global risks.

According to forecasts by Aon Securities, this figure may be exceeded in 2017: during the first half of the year, a record amount – $6.4bn – of catastrophe bonds are due to reach maturity, with the expectation that their sponsors will seek replacement capacity in the marketplace. This trend will be assisted by the prevailing competitive pricing environment in the catastrophe bond sector when compared to traditional re/insurance solutions.

For investors, catastrophe bonds have offered generally strong returns when compared to more traditional investment options and highlight the value of a diversified book of pure insurance risks for investors’ portfolios in the long term.

Looking ahead into 2017, the strength of the catastrophe bond sector seems set to continue, as alternative capital continues to find attractive returns in this asset class, and re/insurers continue to view catastrophe bonds as an important source of capacity.

Catastrophe bonds can now be structured in as little as four weeks with low frictional costs, making them an increasingly viable alternative to the traditional re/insurance product.

KNOWING YOUR A-Z

A – Andrew

B – Bond

C – catastrophe

D – diversified

E – exposed

F – Florida

G – global

H – hurricane

I – investors

J – Japan

K – known

L – launched

M – maturity

N – natural

O – options

P – product

Q – earthQuake

R – re/insurance

S – sponsor

T – term

U – US

V – value

W – windstorm

X – eXceeded

Y – year

Z – zenith

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