Greater issuance of insurance-linked securities in general and catastrophe bonds in particular have helped define the reinsurance market in 2012.

According to a July report by Aon P.L.C.'s Aon Benfield Securities unit, catastrophe bond issuance during the first half of 2012 stood at $3.6 billion, which was just short of the all-time record of $3.8 billion achieved during the same period in 2007.

Despite accounting for less than 10% of overall reinsurance capacity, the influx of capacity provided by insurance-linked securities has helped cushion the market from rapid price and capacity swings in the wake of natural catastrophes, said William Dubinsky, New York-based managing director of Willis Capital Markets & Advisory, a unit of London-based Willis Group Holdings P.L.C. “While the overall capacity of the ILS market remains very much a minority of the volume provided by traditional reinsurance, it plays a very important role in dampening the cycle.”

One factor aiding ILS growth has been an increase in demand from investors in the wake of the financial crisis. As a risk uncorrelated to the financial markets, ILS represent a hedge against uncertainty in the financial world, said Mark Helyar, managing partner of Bedell Cristin Guernsey Partnership, a law firm based in St. Peter Port, Guernsey, that helps companies structure ILS deals.

In addition to providing diversification for the portfolios of institutional investors, ILS may outperform other asset classes, Mr. Helyar added. “There are good returns to be had in this if you have the proper spread of risk,” he said. “For a sophisticated investor, it is a suitable alternative for quick return, but it's very high risk.”

While traditional asset managers and multi-strategy hedge funds invest in insurance-linked securities, most of the money comes from specialist funds dedicated to investing in insurance-linked securities.

“One of the things the ILS market has done is try to isolate for investors the catastrophe risk and take all the other moving parts out of the picture,” Mr. Dubinsky said.

%%BREAK%%

Another indication of the evolution of the catastrophe bond market is the emergence of a secondary market to trade ILS.

“For a subsector of ILS, cat bonds, we do already have a fair amount of trading that goes on,” Mr. Dubinsky said. While traditional reinsurance products are illiquid, the new issue and secondary cat bond market affords investors additional flexibility. “I think it is very important for investors to get secondary market indications based on actual trading and, if necessary, revalue their positions.”

Mr. Helyar said the law firm recently helped arrange the first listing of a private catastrophe bond on a public exchange. In October, Solidum Re Eiger IC Ltd., a Guernsey-based incorporated cell of Zurich-based Solidum Re ICC Ltd., listed $52.5 million in notes from a private reinsurance treaty between Solidum and the California Earthquake Authority on the Channel Islands Stock Exchange.

“One of the main reasons for doing this is transparency so that a prospective investor knows exactly what they are buying,” Mr. Helyar said. “They are not buying bonds in a general reinsurer; they are buying a slice of a specific insurance treaty.”

Another reason to list private deals on a public exchange is that private ILS trades may violate internal governance standards of certain investors, such as pension funds.

Paul Schultz, CEO of Aon Benfield Securities, said the public listing coincides with the larger trends of greater transparency and greater liquidity shaping the ILS market. However, he noted that the listing of ILS on public exchanges does not immediately equate to trading, at least in the short term.

“This is still a more privately traded market and it has not gotten to the point of widespread trading on exchanges, but it doesn't mean that we won't get there at some point,” Mr. Schultz said.