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NEW YORK—A strong fourth quarter pushed 2009 catastrophe bond activity to about $3.5 billion, which experts say signals a healthy comeback for the sector.
A dramatic drop in cat bond pricing combined with strong investor demand boosted issuance, experts say.
“There is a lot of optimism. We've seen a very good fourth quarter with virtually all of the deals upsized from their original target,” said Markus Schmutz, of insurance-linked securities at Swiss Reinsurance Co.'s Capital Markets division in New York.
A total of 18 cat bond transactions in 2009 demonstrated a strong recovery for a market that had stalled during the financial crisis, many experts say. Issuance volume stood at roughly $3.5 billion at year-end—exceeding the $2.7 billion issued in 2008 but off sharply from the record $7 billion issued in 2007, according to data from New York-based reinsurance broker Guy Carpenter & Co. L.L.C. and investment banking arm GC Securities Ltd.
Seven catastrophe bonds totaling about $1.5 billion were issued in the fourth quarter of 2009 vs. zero bonds in the same period in 2008 as investors shied away from the market.
Fourth-quarter 2009 also produced some of the most favorable conditions for sponsors this year, with pricing for insurers to issue cat bonds declining as much as 25% compared with the start of the year, said Swiss Re's Mr. Schmutz. Cat bond spreads that determine the price for sponsors tightened considerably as investors were willing to accept lower returns, he said.
Also driving down costs for insurers was strong investor demand. Compared with other asset classes, “investors are very pleased with the way cat bonds have performed this year, and we're seeing a lot of new money come into the sector,” said Al Selius, head of New York operations for Securis Investment Partners L.L.P., a London-based insurance-linked securities investment firm.
In addition, some $660 million in maturing bonds was reinvested in the sector during the fourth quarter, said Chi Hum, global head of distribution at GC Securities Ltd. in New York. “Investors are basically flush with cash and they need to put that money back to work,” he said. GC Securities estimates another $2 billion in maturing bonds will be redeployed in the first half of 2010.
The influx of additional capacity has resulted in generally larger deals at better prices, observers say. One of the largest deals of 2009, a $500 million cat bond placed by Travelers Indemnity Co., originally was marketed to investors with a target total of $250 million. When it closed last month, it doubled in size due to strong investor demand. The bond, Longpoint Re II Ltd., provides the Hartford, Conn.-based insurer with multiyear reinsurance protection against U.S. hurricane risks.
Two other fourth-quarter bonds were upsized, including Swiss-based Flagstone Reinsurance Holdings Ltd.'s bond, Montana Re Ltd., from $120 million to $175 million. The bond covers U.S. hurricane and earthquake risks for three years.
In addition, Zurich-based Swiss Re's bond, Successor X Ltd., increased from $60 million to $150 million by the time it closed last month. The bond covers losses from California earthquakes and U.S. Atlantic hurricanes.
Insurers and reinsurers covering peak perils, including U.S. hurricane, U.S. earthquake and European windstorm risks, dominated the 2009 deals. While experts expect demand for what is known as the “big three” perils to drive market growth, other deals in 2009 sought protection from losses related to Japanese earthquakes, Mexican catastrophes and California earthquakes.
Observers say several trends emerged in 2009 that point to a shift in the market. For example, in previous offerings, reinsurers largely dominated cat bond issuance, but in 2009, primary insurers backed about 60% of the bonds.
“The primary companies are looking towards the cat bond market to be a core part of their capacity source and they are using the capital market as a way to diversify and balance out their traditional reinsurance,” Mr. Hum said. For insurers “that have to hedge an inbound book of business, having an alternative source of capacity is huge; it's strategic,” he said.
Meanwhile, reinsurers are being more “opportunistic,” Mr. Hum said. “We didn't see reinsurers start to participate in the market in 2009 until the pricing really became favorable.”
In addition, Mr. Hum said many sponsors looking to integrate cat bonds into their overall program have sought additional flexibility. For example, Travelers' bond is structured in two tranches and features a “dual maturity” issuance. The $250 million Class A notes provide three years of protection against certain U.S. hurricanes and $250 million Class B notes provide similar protection for a four-year period. “It gives them more flexibility and allows them to better manage through the pricing cycle,” Mr. Hum said.
GC Securities acted as a joint underwriter on the deal, along with Deutsche Bank Securities and Swiss Re Capital Markets.
As for 2010, observers say they are optimistic and the pipeline for potential deals is strong.
“Now that spreads have returned to precrash levels, we would envision volumes returning to precrash levels,” said Peter Nakada, Hackensack, N.J.-based managing director for Newark, Calif.-based modeling firm Risk Management Solutions Inc.
Mr. Nakada estimated 2010 volume could be $6 billion to $8 billion.