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More risk managers adding cat bonds to their bag of tricks

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SAN DIEGO — Risk managers are increasingly interested in using catastrophe bonds to obtain insurance coverage and gain immediate access to capital in the event of a claim.

And while cat bonds are better suited to large buyers, parametric insurance products are simpler to set up and can provide buyers quick access to capital after a specified trigger such as a named storm, offering an alternative for midsize buyers, experts say.

“This really is an up-and-coming issue for risk management,” said David Goodwin, a partner at Covington & Burling L.L.P. in San Francisco, who chaired a session on the topic at the Risk & Insurance Management Society Inc.'s annual conference in San Diego this month.

The use of catastrophe bonds, which typically have been used by insurers as a source of reinsurance capacity, is on the increase among primary insurance buyers, said Jamie Crystal, executive vice president at insurance broker Crystal & Company in New York.

And there is interest among investors in buying cat bonds because they are viewed as a way to diversify risk, as they are not correlated with other forms of investment, and yields are seen as attractive, Mr. Crystal said.

Cat bonds transfer a specific risk, or set of risks, to investors, Mr. Crystal said, typically setting parameters or triggers, such as a named storm hitting a predefined metropolitan area.

“You can slice and dice these any way you want,” he said.

Laureen Coyne, retired director of risk management for the Metropolitan Transportation Authority in New York, told conference attendees that a sudden lack of affordable insurance capacity had prompted the MTA to examine the possibility of buying a cat bond.

In the aftermath of Superstorm Sandy in the fall of 2012, the MTA was faced with a loss of about $5 billion, and its insurance coverage did not come close to that amount, Ms. Coyne said. There was a contraction in the amount of insurance capacity available to the MTA and an almost doubling of its rates, she added.

Consequently, the MTA began to explore the possibility of using a cat bond, and the MetroCat Re Ltd. Series 2013-1 bond became the first ever to contain storm surge as a peril.

The bond, Ms. Coyne explained, gave the MTA's captive insurer “a fully collateralized source of multiyear reinsurance protection for storm surge risk” and contained a parametric trigger limited to named storms or earthquakes occurring in any of eight named states.

Other large corporations have also used cat bonds to obtain insurance coverage, the panelists said.

For example, in October 2015, Ms. Coyne said, the Washington-based National Railroad Passenger Corp., better known as Amtrak, issued the PennUnion Re Ltd. Series 2015-1 cat bond to give it about $275 million in protection for damage to infrastructure from natural events including storm surge, wind and earthquake in the Boston-to-Washington corridor.

“Each transaction can learn from the last one, and it becomes a better and better product,” said Ms. Coyne.

Because of the frictional costs — such as the use of lawyers and bankers — involved in putting together the structures, cat bonds tend to be about $100 million or more in size, said Mr. Crystal.

But for smaller buyers, one alternative is parametric insurance products, he said.

Parametric insurance mimics many of the characteristics of cat bonds, but instead of the risk being borne by investors it is taken on by insurers, he said.

Buyers of such coverage do not need to provide underwriting information to insurers since the product works upon a trigger — such as a named storm — occurring rather than indemnifying a loss, Mr. Crystal said.

Parametric insurance products can provide buyers with ready access to capital immediately after a loss from a peril such as a windstorm or earthquake, he said.

No adjusters are required, so payment is swift, he said.

Parametric insurance products typically take less time to structure than cat bonds, Mr. Crystal said, and can be annual or multiyear.