Catastrophe bonds see growth as they evolve to cover more risks

Growing volume, a broadening group of cedents and investors, and novel structuring arrangements are shaping the market for catastrophe bonds and other insurance-linked securities.

Cory Anger, New York-based global head of ILS structuring at GC Securities, said one of the most evident market trends has been a shift toward bonds using indemnity triggers vs. parametric or indexed triggers. Indemnity triggers are based on sponsors' actual losses.

“A big trend that has been a big focus this year is indemnity-based protection,” Ms. Anger said, noting that 74% of the bonds placed so far this year have had indemnity triggers.

The move is part of a broader evolution of the market, said Markus Schmutz, New York-based head of ILS structuring and origination for Swiss Re Capital Markets.

“Post-Hurricane Katrina, the market was very focused on plain vanilla structures and index-based transactions, but over time we have seen that investors have gotten more comfortable with more complex trigger structures, such as indemnity triggers,” Mr. Schmutz said.

The growing demand for insurance-linked securities from investors that include pension funds, asset managers, endowments and hedge funds means that cedents can demand terms and conditions closer to traditional reinsurance, “which will spur additional issuance from sponsors” and play a greater role for insurers looking to diversify their portfolios, Mr. Schmutz said.

Sharon Binnun, chief financial officer of Tallahassee, Fla.-based Citizens Property Insurance Corp., said the state-run property insurer of last resort issued its first catastrophe bond in May 2012.

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“We wanted to diversify the reinsurance program, so we budgeted for both traditional reinsurance and catastrophe bonds in 2012,” she said. “We saved some money by bringing in competition.”

Ms. Anger said one expansion in recent catastrophe bonds affects the types of tropical storms that can be covered. “There has also been a big focus this year to get the coverage to respond not just to hurricanes but to named storms,” she said.

“We have seen increased flexibility in how the covers can reset in allowing the protection — at election of the sponsor — to either get riskier and have a commensurate, predefined price increase for taking on more risk, or make it less risky and decrease the cost at a predefined level that is established at the inception of the transaction,” Ms. Anger said.

This ability to make changes during the life of a catastrophe bond is an important structural innovation, Mr. Schmutz said.

“In the past when you issued a bond, it had a certain risk profile or probability of triggering the transaction,” he said. “Investors are now more comfortable to have a more variable risk profile.”

Rick Miller, New York-based co-head of Towers Watson Capital Markets, said market innovations, such as private placement, have helped reduce the cost of issuing insurance-linked securities and made them more competitive with traditional reinsurance.

“Leaving alone brokerage and investment banking fees, you still had legal fees, modeling fees, rating agency fees and trustee fees” in a more traditional catastrophe bond placement, Mr. Miller said. “Private placement can cut these fees by 75%.”

Private placement allows smaller insurers to tap catastrophe bonds, he said. “Previously, access was only reserved for large, multinational corporations and effectively limited” superregional and specialty underwriters, he said.

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Bill Dubinsky, New York-based head of ILS at Willis Capital Markets & Advisory, said the evolution of the insurance-linked securities market makes it more attractive to larger players. For example, a large corporation could take advantage of the securities to reduce their total cost of risk and gain access to larger limits than they could normally access for a single property, he said.

“The most notable thing so far is that we have not seen any insureds accessing the market directly,” Mr. Dubinsky said. “It's certainly not impossible.”

Another possible evolution is expanding the types of perils covered or combining perils, he said.

“For example, we may have some more ability to do things such as flood risk and pandemic risk,” Mr. Dubinsky said.

“Pandemic risk has already been done in the market, but I think we will see more of it.”