Swiss Re expects cat bond deluge

Insurance-linked securities, often referred to as catastrophe bonds, allow the issuer to transfer their exposures to highly severe, highly unlikely insurance risks to capital markets investors.

With poor performance in the fixed income market in the last year, investors have been keen to load up on new catastrophe risk issues, which offer excellent diversification, as they are uncorrelated with the other financial risks in investors’ portfolios. The higher demand has lowered the cost to issuers, making insurance-linked securities a more affordable means of risk transfer.

According to Swiss Re, several factors will drive activity in the alternative risk transfer market in the coming year, of which insurance-linked securities are just a small part.

Martin Albers, a member of Swiss Re's executive board and head of risk solutions, cited low premium income due to the soft insurance market of recent years, estimated record industry losses of $70 billion in 2001, and the impact of dismal equity markets on insurers' investment portfolios as the drivers of significant increases in pricing and reduction in risk appetite among insurers. In this hardened market, not only are corporations paying more, but they are being offered less protection as insurers lower policy limits and by raise deductibles.

Reinsurers like Swiss Re are seeking to write more business in the current high premium environment, but in order to assume higher returning risk they must transfer away the lower performing risk written in the soft insurance markets of past years. One tool for this is insurance-linked securities.

Figures presented by Swiss Re suggest that despite significant investment in new and existing insurance companies after September 11, insurance capacity as a whole is still lower than it was prior to the terrorist attacks. Gary Ransom, a managing director at Swiss Re subsidiary, Fox-Pitt, Kelton, added that the new capital was conditioned to seek only high return business, and would therefore not significantly drive pricing down. This should also maintain demand for alternative risk transfer, he said.

The bulk of the alternative risk transfer market, which Swiss Re says has grown from 26% of total commercial lines to 37% this year, is comprised of self-insurance, captives and finite reinsurance facilities.