Catastrophe bonds, used by investors to bet against natural disasters, advanced for a record 10th straight week on fewer storms in the U.S. and improved capital markets.The Swiss Re Cat Bond Price Return Index rose 1.4 percent to 93.03 on Sept. 11, the biggest increase since September 2004. It’s the longest string of weekly gains since 2002, when Swiss Reinsurance Co. began tracking the data.
The U.S. has escaped major onshore storms this year after hurricanes Ike and Gustav contributed to $25.2 billion in catastrophe losses in 2008. If there are no major catastrophes, investors stand to benefit. Insurers and reinsurers sell the bonds and use them to cover claims if a disaster strikes.
“In the middle of hurricane season, prices should be going the other way because people are concerned and scared about taking a loss,” said David Priebe, chairman of global client development for reinsurance broker Guy Carpenter & Co. “It’s unique in the sense you are seeing bond pricing increasing.”
The bonds fell last year following the collapse of Lehman Brothers Holdings Inc. and after six hurricanes struck the U.S. The National Oceanic and Atmospheric Administration revised its hurricane outlook last month to a near-normal to below-normal season, after previously predicting a near-normal season.
Lehman’s collapse spurred price declines from September to May as the failed investment bank had sold contracts to protect returns on catastrophe bonds. Lower prices, a higher yield and a separation from other financial markets began to renew investor interest this year, Priebe said.
Investors Comfortable
It wasn’t until 2009 that “both sponsors and investors alike were comfortable with the overall cat-bond mechanism,” Priebe said. “The issues that went out so far this year were, from an investor’s perspective, priced very attractively.”
Investors may earn as much as 17 percentage points above benchmark rates for taking the risk that a disaster could cost them their principal, according to data compiled by Bloomberg....MORE
And from FT Alphaville:
Cat bonds and the ‘perfect storm’
...Much to the relief of cat bond investors, the US has escaped major onshore storms this year after hurricanes Ike and Gustav contributed to $25.2bn in catastrophe losses in 2008, Bloomberg notes.This despite the current hurricane season in the US, when prices could be expected to go the other way amid concerns about weather-related losses.
But lower bond prices, a higher yield and a separation from other financial markets have driven a revival in investor interest this year, David Priebe, of reinsurer Guy Carpenter & Co told Bloomberg.
As the FT notes, only two cat bonds were sold in the second half of 2008, comprising a total issuance of just $320m, and nothing was done in the market between September and February this year, according to reinsurance broker Aon Benfield.
Total annual issuance tumbled from a record $7bn for the 12-month period ending June 30 2007 and $5.8bn in 2007-08 to just $1.7bn in 2008-09.
But improved capital markets have helped boost cat bond prices, and investors may earn as much as 17 percentage points above benchmark rates, Bloomberg calculates. Already, notes Aon Benfield, cat bond issuance has climbed to $2bn so far this year and could increase to as much as $4bn by year-end.
In addition, recent cat-bond deals have limited the kind of collateral that can be used to cash, government securities, and government-guaranteed bank debt, or have done away with a swap counterparty completely. The problem with the deals related to Lehman Brothers, according to Aon Benfield, was that “no one anticipated that a swap counterparty backing a cat bond could collapse and the collateral also become impaired at the same time. The collapse of Lehmans showed that it could”.
But investors eyeing cat bonds should move soon. The bonds face competition from derivatives that can be used to transfer catastrophe risk - both OTC and exchange traded. And, as the FT notes, the OTC market is based on bilateral swaps called Industry Loss Warrants, which pay out if total industry losses from an event breach certain levels.
