Technical report: ART - Catastrophe bonds: another bond adventure?

(From Reinsurance)

Byline: Angela Koller.

With the January 2007 renewals behind us, it is a good time to take stock and reflect on the performance of the reinsurance market in 2006. Hurricanes were expected to hit the property and casualty market but did not materialise. The sky-high US property/catastrophe rates charged in anticipation of heavy losses have led to bumper profits being reported by many (re)insurers. Throughout 2006, the reinsurance market experienced an influx of alternative capital, primarily in the form of catastrophe bonds and sidecar arrangements.

These types of alternative reinsurance have been around for over a decade, and their use has been traditionally associated with hard reinsurance markets. In this respect, 2006 provided a perfect environment for alternative reinsurance to flourish.

Not surprisingly, issuance of catastrophe bonds now stands at about $6bn, and their outstanding value has tripled in the past five years. Traditionally issued through special-purpose vehicles (SPVs), these bonds are now increasingly issued directly by insurance companies and even by the original insured. For example, the Mexican government issued a $160m earthquake bond in 2006.

However, although catastrophe bonds and sidecars raised approximately $8bn in 2006, they still only account for only 3% of the capital of the global reinsurance market, according to a recent study by Standard & Poor's (S&P). Does this suggest that despite a healthy reinsurance appetite from fixed-income investors, there are some barriers limiting the growth of these instruments? To answer this, let's examine how catastrophe bonds meet insurers' and investors' needs.

What is the benefit to traditional reinsurance buyers?