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Cat bond market could be boosted by Japanese crisis

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The market for bonds designed to cover  natural catastrophes has taken a hit since the disasters in Japan last month,  but could profit in the end from such dramatic events, specialists say.

“Cat bonds” are a way for reinsurance companies to transfer part of the  risks they cover to financial markets.

While providing a layer of protection for issuers, they are also a  lucrative investment opportunity, with an average rate of return in 2010 of 11  percent.

Investors accept the risk of losing some or all of their money in the rare  event that the specific catastrophe defined in the bond’s issuance occurs  before it matures, which is typically after a relatively short period.

“Very often it’s about covering a 100-year event. So it’s pretty safe for  investors,” said Steve Evans, director of the Internet group Artemis.bm that  specialises in risk transfers.

The earthquake and tsunami that struck Japan on March 11 closely resemble  the kind of events that cat bonds are meant to cover however.

Dirk Schmelzer of the Swiss investment group Plenum Investments said: “It  remains to be seen if cat bonds were hit” by the disasters. “It is not  improbable.”

Schmelzer estimated that a total of 11 cat bonds worth $1.7 billion were  potentially exposed to losses from the events in Japan.

The market is of course very worried about that possibility, and bond  values have fallen sharply since March 11.

“It is a short term reaction given the current uncertainty,” Schmelzer said.

He was upbeat however about the longer term viability of a niche global  market with an estimated value of 13 billion dollars.

One reason is because from an investor’s point of view, potential losses in  Japan from cat bonds are small compared with the overall losses, which risk  assessment company AIR Worldwide has put at $20-30 billion.

Another is that future regulations on insurance shareholder funds known in  the European Union as Solvability 2 could incite insurers to transfer more of  their risks to financial markets.

Finally, higher insurance premiums likely to be charged following a string  of disasters this year in Australia, Japan and New Zealand could boost the  rate of return on cat bonds issued by insurers, Schmelzer said.

And the huge costs of natural catastrophes, which caused $218 billion in  damage last year, more than three times the 2009 level according to the  reinsurance group Swiss Re, has also sparked interest among some governments.

Israel, South Korea and Taiwan are among those looking at the possibility  of bond issues, Evans noted.

Such bonds nonetheless remain a kind of luxury financial product for  insurance groups, given high rates of interest they have to offer and strict  clauses that make benefitting from the no-payment aspect very rare.

Of the more than 300 cat bonds issued worldwide, issuers have only been  able to defer payment on two since 2005 according to information provided by  Moody’s investors services.

“It’s good to be a cat bond investor. But that means it’s bad to be on the  other side of the trade,” said Daniel Indiviglio, and editorialist at the US  magazine The Atlantic who questions their ultimate worth.

Frankfurt, 2011 (AFP)