Cat bond activity set for ‘dramatic’ rise, claims Stonberg

The large pay-out expected by the reinsurance industry following the terrorist attacks of September 11, combined with a recent trend towards more capitalised investment banking firms, could stimulate a “dramatic increase” in the growth of the catastrophe bond sector, said Stephen Stonberg, managing director of risk transformation at JP Morgan Chase, during his keynote address at Risk magazine’s Credit Risk Summit 2001 Europe in London.

Stonberg claimed that although catastrophe bonds fulfilled a market need when invented by Goldman Sachs several years ago – with insurers diversifying risk concentrations and investment banks keen to take on non-correlated assets – the typically stronger capitalisation of reinsurers compared with standalone investment banks presented a tangible barrier to the need for cat bonds. Essentially reinsurers had large amounts of capital and did not have a significant incentive to lay-off risk.

But the large pay-outs required by the reinsurance industry associated with the September 11 attacks – which some believe could be as high as $40 billion – will seriously impact the capitalisation of reinsurers in the future and could result in some receiving credit rating downgrades. Meanwhile, the recent merger trend of investment banks with large commercial banks, like JP Morgan with Chase Manhattan, has created highly capitalised financial institutions capable of taking on more risk. The dual impact should result in reinsurers being stimulated to lay off risks into the capital markets.

“I think [Goldman] got the right idea, but the timing was wrong because the insurance industry was extremely overcapitalised, while the banks were undercapitalised. And through cat bonds they were trying to take risk out of the over-capitalised industry and put it in the under-capitalised industry. Typically you want to do it the other way around. So we never really saw the cat bond market take off. I think that is going to change dramatically,” said Stonberg.

A spokesperson for Munich Re, the world’s largest reinsurer, told RiskNews last month that the firm would “completely rethink” its risk management practices in the wake of September 11. She added that it was highly likely that Munich Re would increasingly turn to the capital markets as a means of laying-off risk in the future.

Credit rating agency Fitch, meanwhile, believes the catastrophe-linked securities market could grow to $2 billion in 2002, due to the changed market dynamics. Fitch believes a likely increase in insurance rates, reductions in insurance capacity and a perceived weakening in the credit status of reinsurers will make cat bonds a more attractive alternative to traditional insurance. But Fitch analysts believe a likely increase in cat-risk bond spreads will partially offset the increase in reinsurance prices.