The catastrophe bond market appears set to rebound during the second half of the year despite a slower pace during the first half caused by several factors.

A soft traditional market, the March 11 earthquake and tsunami in Japan, and changes to Risk Management Solutions Inc.'s U.S. hurricane model all contributed to the slow pace of first-half cat bond issuance, market experts say.

However, investor demand for insurance-linked securities remains high and the market has largely worked through the issues that confronted it earlier this year.

“Broadly speaking, we see what we would call probably a very active second half of the year. We've had a couple of transactions already,” said Paul Schultz, president of Aon Benfield Securities Inc. in Chicago.

Mr. Schultz said he sees a good pipeline of transactions likely to come to market, which should carry over into 2012.

According to New York-based GC Securities, an affiliate of Guy Carpenter & Co. L.L.C., nearly $1.61 billion in new catastrophe bonds were during the first six months of 2011, with nearly $10.64 billion in outstanding risk capital in the market at the end of the second quarter (see chart).

That's down from last year, when there was $2.35 billion in new issuance during the first half with total risk capital in the market standing at $11.82 billion. There was more than $12.18 billion in risk capital in the market at the close of 2010, according to GC Securities.

“We definitely have seen an active year this year; particularly we have seen another active third quarter,” said Cory Anger, managing director and global head of insurance-linked securities at GC Securities.

“If you kind of look back to the first half of the year, what you've probably seen is that issuance is a little bit slower than for the same period the year before,” said Markus Schmutz, head of insurance-linked securities structuring and origination at Swiss Re Capital Markets Corp. in New York.

Mr. Schmutz noted the RMS model change as one factor slowing first-half cat bond issuance. “A lot of people who were thinking about doing issues had some questions about how would the market react to the model change,” he said. “They also had some questions about reinsurance renewals at July 1.”

“Even today I think investors and issuers are working through some of the changes” to the RMS model, said Aon Benfield's Mr. Schultz. “It still continues to be an issue for the market.”

While the earthquake in Japan appeared to slow cat bond issuance, the market's response seems appropriate, the experts say.

It's possible the Japan loss caused a “lag” in new issuance while the market digested the event and how it played out. But, said Mr. Schultz, “I don't think it changed any of the issuance that was going to come to market.”

“What's happened in terms of catastrophic events around the world hasn't really had that much of an impact,” he said. “The market does expect to pay losses from time to time.”

“Of the outstanding cat bond limit, about $1.5 billion was exposed to Japanese earthquake risk,” said GC Securities' Ms. Anger. One issue, Muteki Ltd., paid its full limit of approximately $300 million. That issue provided earthquake coverage to Zenkyoren Ltd., the Japanese National Mutual Insurance Federation of Agricultural Cooperatives, under a deal in which Munich Reinsurance Co. provided reinsurance to the Japanese mutual, then securitized the exposure through the Muteki bonds.

Swiss Re's Mr. Schmutz noted that the Muteki transaction functioned as designed.

“(Investors) took the loss and moved on. We haven't really heard of anyone panicking and leaving the market,” he said. “Really it serves as a very nice proof of the product and the concept.”

Roger G. Beckwith, vp and secretary of Lane Financial L.L.C. in Chicago, had a similar view of the market's response to the catastrophe in Japan. “Things recovered in a pretty reasonable period of time,” he said.

The third factor slowing first-half issuance was the fact that prior to the quake and tsunami in Japan, traditional markets were very aggressive, Mr. Schultz said. “We actually had a couple of bonds that were scheduled to come to market that just went back to the traditional market because it was just more efficient for the clients,” he said.

“We still are working through the RMS issue. We think the other ones have been resolved,” Mr. Schultz said. “We think we will work through the RMS issue by the end of the year.”

“We started the year with an estimate of $5 billion to $6 billion that was going to come to market. We've sort of revised that to $4 billion to $5 billion,” he said.

Investor interest in insurance-linked securities remains strong. “We've seen investor support continue to be robust,” Ms. Anger said.

With market proponents regularly citing the uncorrelated nature of cat bonds to other investment instruments, the market might be in a position to benefit from stock market volatility.

“We really have accelerated bringing new investors into the space and it really started after the global financial crisis in 2008,” said Mr. Schultz. While most asset classes producing negative returns after the financial crisis, insurance linked-securities produced positive returns, he said.

“The fact that (cat bonds) have shown very little correlation (with other investment risks) makes them an attractive option for many investors,” Mr. Schmutz said.

WIth U.S. windstorm risks the most common exposure in the ILS market, there is interest from investors in increasing the diversity of ILS exposures, according to Lane Financial's Mr. Beckwith.

“I think we've seen with recent deals that there's a lot of interest in diversifying ILS,” he said. “So things that are non-U.S. wind or non-U.S. are sought after. You've had a pretty good reaction in the market to non-U.S. wind deals.”

Recent events could drive the shape of some cat bonds going forward. For example, the frequency and severity of U.S. windstorms and the number of catastrophic events and total losses this year might lead some issuers to look to the cat bond market to cover accumulations of losses.

“(An) area that we're seeing a lot of focus on now from a U.S. perspective is around aggregate structures, which isn't surprising, given that 2011 has been a historically severe year,” Ms. Anger said.

Tornado frequency and severity coupled with the Japanese earthquake led to insurance and reinsurance losses, “which aren't negligible,” said Mr. Schmutz. That has led some to consider aggregate covers to address the “extraordinary frequency of smaller events,” he said.

Ms. Anger noted that supply chain disruptions resulting from the disaster in Japan also have prompted discussions about corporations using the ILS market to address supply chain risks. She cited this year's €150 million ($215.9 million) Pylon II Capital Ltd. European windstorm issue by Paris-based Electricite de France S.A. as a possible model.

“For them, the original catalyst for putting it in place was the loss of income and business interruption from European windstorms,” as it could provide property protection, she said. “When we see very significant events that have had an impact on corporations, we do see increased focus on alternative solutions.”