October 13th, 2009

Cat Bond Update: Third Quarter 2009

Posted at 12:30 AM ET

GC Editor

gc-securities-logoGC Securities, a division of MMC Securities Corp.*
Contact

The third quarter is traditionally quiet for the catastrophe bond market, and 2009 was no exception. Two transactions were closed, resulting in USD412 million in new risk capital.1 Nonetheless, risk capital issued was up by a third relative to the same quarter last year, as both catastrophe bonds issued were upsized considerably. The consensus estimate for the entire year remains USD3 billion to USD4 billion, implying a strong fourth quarter for primary issuance.

Issuance Activity

New risk capital issued in the third quarter was up 28.8 percent from the third quarter of 2008. Last year, two transactions resulted in USD320 million in new risk capital issued, while this year, two deals, both of which closed in late July, resulted in risk capital of USD412 million.

Parkton Re Ltd., on which GC Securities acted as co-lead manager and joint bookrunner, was one of the few catastrophe bond issuances to be upsized this year — and the only deal so far this year to price below its initial price guidance. The initial target placement of USD125 million ultimately led to a USD200 million transaction as well as price tightening. Parkton Re was sponsored by the North Carolina Joint Underwriting Association and North Carolina Insurance Underwriting Association (collectively the NC JUA/IUA), a first-time sponsor to the catastrophe bond market, and covers North Carolina hurricane losses based on an indemnity trigger.

Eurus II Ltd, which closed a day later, was upsized to EUR150 million (from EUR75 million) and covers European windstorm risk (specifically, in Germany, United Kingdom, Netherlands, France, Belgium, Denmark and Ireland). The catastrophe bond replaced Eurus Ltd, a USD150 million bond that matured on April 8, 2009.

For the first three quarters of 2009, 11 catastrophe bonds were issued, for USD1.79 billion in risk capital. This trails the result posted for the first three quarters of 2008: 13 issuances, amounting to USD2.69 billion in catastrophe protection. Year-to-date issuance activity is down 33.5 percent from the same period in 2008.

chart_1

Catastrophe Bond Redemptions

In the third quarter of 2009, USD300 million in catastrophe bond risk capital matured, bringing the year-to-date total to USD2.54 billion. Another USD660 million is scheduled to mature in the fourth quarter of this year.

Risk Capital Outstanding

Total risk capital outstanding grew from the second quarter of 2009 to the third quarter, reaching USD11.3 billion — up from USD11.19 billion. This represents a net increase of USD112 million (1 percent). This follows consecutive quarters of declines, though, as the first quarter posted a year-over-year decline of USD75 million, with the second quarter off USD779 million.

Risk capital outstanding peaked at the end of 2007, at USD14.02 billion. It then fell to USD12 billion by the end of 2008 before reaching USD11.3 billion at the end of July 2009. The current level is consistent with that of mid-year 2007.

chart_2

Issuance Composition

Of the USD412 million issued in the third quarter of 2009, USD200 million had exposure exclusively to U.S. hurricane, and USD212 had exposure to European windstorm. The U.S. hurricane catastrophe bond was indemnity-triggered and sponsored by the NCJUA/IUA, an insurer. This was the first catastrophe bond sponsored by the NC JUA/IUA. The European windstorm catastrophe bond was sponsored by a reinsurer and used a parametric trigger.

Industry Loss Warranties

Consistent with catastrophe bond market, industry loss warranty (ILW) trading was light during the third quarter of 2009. Pricing for the most part remained flat throughout the quarter, with no major trades prompting significant pricing adjustments. Pricing remains down 15 percent to 20 percent relative to January 2009 and is now consistent with 2007 mid-wind season levels. In general, capacity sellers continue to outnumber capacity buyers.

Outlook for the Fourth Quarter

Last year, the fourth quarter was silent, primarily because the financial crisis reached its peak during this period. This was an anomaly in the history of the catastrophe bond market, since this is usually the second busiest quarter of the year. Based on the current pipeline, it looks as though the fourth quarter of 2009 will represent a return to the norm.

During the first half of this year, when global financial market conditions were more distressed, asset managers contended with greater uncertainty regarding redemptions and the valuations of their existing holdings. The prevailing perception was that insured losses generated by Ike, Gustav and other natural catastrophe events combined with asset write-downs and increased capital costs due to the 2008 credit crisis could contribute to traditional capacity shortfalls for peak catastrophe perils (particularly U.S. hurricane) at the June 1, 2009 and July 1, 2009 renewals. In this environment, the catastrophe bond market was driven by minimum return thresholds. This prompted the sponsors that did elect to issue bonds to increase the risk embedded in their transactions, improving the price efficiency of their protections.

As conditions have improved throughout the year, and insurance-linked securities (ILS) offerings have enhanced their collateral solutions (with increasing focus on U.S. Treasury money market funds), the stronger demand for ILS issuance and increasing capacity of investors has prompted a shift in the predominant driver in the ILS market relative to the beginning of the year. Whereas in the first and second quarters of 2009, many ILS investors were seeking to maintain minimum spread levels, in the currently prevailing environment there is greater focus on capital deployment and stimulating additional primary issuance, which is contributing to spread tightening across the market in general and most sharply for 2009 vintage transactions (which are benefiting from enhanced collateral solutions).

Historically, the fourth quarter has been the second most active quarter in terms of risk capital issued, accounting for 28 percent of total issuance since the market’s inception. Consensus estimate for 2009 total issuance remains from USD3 billion to USD4 billion, implying a fourth quarter issuance rate of USD1.2 billion to USD2.2 billion. If this level is attained, it would represent 40 percent to 55 percent of the issuance in 2009 and would make the fourth quarter the most active of 2009. A fourth quarter accounting for greater than 40 percent of any year’s total issuance has been reached only once (in 2004).

Though a USD1.2 to USD2.2 billion fourth quarter intuitively seems like a stretch, several factors suggest that it may be attainable. In the third quarter, both transactions were placed within (or, in the case of Parkton Re Ltd.,) below spread guidance and well inside the spread levels associated with transactions completed in the first half of the year. Both were also upsized significantly relative to initial placement targets.

The fundamentals of the ILS market also point to a strong fourth quarter for this year. The USD660 million scheduled to mature this quarter will be followed by another USD518 million in January 2010, and these redemptions should result in an increase in demand for new issuances. Further, consistent positive movements in existing bond prices in the secondary market should exert downward pressure on required clearing spreads on fourth quarter primary issuance. In particular, 2009 vintage transactions, which use “next generation” or clean collateral solutions are in high demand.

Improvements in general financial stability around the world and the positive perceptions of ILS as an important asset class for significant pools of traditional investment capital (e.g., pension funds, endowments and sovereign wealth funds) in the wake of the recent credit crisis may support higher demand for the direct investment in insurance risks, as well.

Spreads have tightened on similarly rated alternative investments. As an example, the yield on BB-corporate debt, which was near an all time high at the beginning of 2009, has declined by more than 45 percent during 2009 year to date.2 The general easing of prevailing yields across assets that are often compared to cat bonds should make it easier for ILS investors to accept lower spreads while still generating competitive returns.

A benign 2009 wind season thus far in terms of insured losses (though the season has been roughly average in terms of storm formation) is also making catastrophe bonds more attractive to both sponsors and investors. Only one Atlantic hurricane, Hurricane Bill, made landfall in North America. Some evidence suggests this is due to unusually favorable steering currents, which are pushing hurricanes that form from tropical African waves to the north (i.e., away from the eastern coast of the United States and the Gulf of Mexico). Though the outcome is not yet certain (September 10 marks the official middle of U.S. hurricane season), a season of light (or no) insured losses should contribute to further spread tightening in the catastrophe bond market.

The tightening of spreads is bringing the ILS market back from the unusually wide spread levels sustained in the first half of 2009. Elevated catastrophe bond spreads — especially when contemporaneous to adequate traditional reinsurance capacity that has not increased its pricing by the same magnitude as the capital markets from 2008 to 2009 have had a dampening effect on issuance activity, particularly from reinsurers. Sponsors that were not inclined to issue during the first two quarters of 2009 because of pricing concerns may renew interest in catastrophe bonds, as the other benefits of cat bond protection (e.g., multi-year fixed pricing, fully collateralized cover and a sourcing capacity from an alternative providers relative to traditional reinsurance and retrocession providers) not only remain but will now be attainable at more favorable price points.

Contributors:

  • Chi Hum, Managing Director
  • Cory Anger, Managing Director
  • Hong Guo, Managing Director
  • Ryan Clarke, Vice President
  • Brad Livingston, Risk Analyst

Footnotes:

  1. This includes the Eurus II Ltd. EUR150 million transaction converted to US Dollars at an exchange rate of USD1.41:EUR1. For Euro denominated issues, amounts are converted to US Dollars according to the prevailing exchange rate on the closing date of each transaction.
  2. BB-corporate yields measured by using the Merrill Lynch BB Index (1 — 10 year maturities). Bloomberg symbol: H5A1

* Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies, Inc. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.


Guy Carpenter & Company, LLC Terms and Conditions of Use

PLEASE READ THESE TERMS AND CONDITIONS OF SERVICE (“TERMS”) BEFORE USING THIS SITE.

By continuing to access or use this site, or any service on this site, you signify your acceptance of the TERMS. From time to time, Guy Carpenter & Company, LLC (“Guy Carpenter”) may modify the TERMS. Accordingly, please continue to review the TERMS whenever accessing or using this site. Your use of this site, or any service on the site, after the posting of modifications to the TERMS will constitute your acceptance of the TERMS, as modified. If, at any time, you do not wish to accept the TERMS, you may not use the site. Any terms or conditions proposed by you that are in addition to or which conflict with the TERMS are expressly rejected by Guy Carpenter and shall be of no force or effect.

1. User Assent to Terms and Conditions of Service

You represent that you have read and agree to be bound by the TERMS for GCCapitalIdeas.com. You further agree: (i) to comply with U.S. law regarding the transmission of any data obtained from the Service (as defined herein) in accordance with the TERMS; (ii) not to use the Service for illegal purposes; and (iii) not to interfere or disrupt networks connected to the Service.

2. Disclaimer

All content provided on this Web site is based upon information which we believe to be reliable and should be understood to be general insurance information only. It is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. Consult your reinsurance/insurance advisors with respect to individual coverage issues.

Guy Carpenter makes no representations or warranties, express or implied, with respect to the accuracy or reliability of the content contained on this Web site. Readers are cautioned not to place undue reliance on any historical, current or forward-looking statements. Guy Carpenter undertakes no obligation to update or revise publicly any historical, current or forward-looking statements, whether as a result of new information, research, future events or otherwise.

Statements concerning, tax, accounting, legal or regulatory matters should be understood to be general observations based solely on our experience as reinsurance brokers and risk consultants, and may not be relied upon as tax, accounting, legal or regulatory advice which we are not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas.

3. Intellectual Property

This Web site, including, but not limited to, text, content, photographs, video, audio, and graphics (the “Service”), is protected by copyrights, trademarks, service marks, international treaties and/or other proprietary rights and laws of the U.S. and other countries. The Service is also protected as a collective work or compilation under U.S. copyright and other laws and treaties. All individual articles, columns and other elements making up the Service are also copyrighted works. You agree to abide by all applicable copyright and other laws, as well as any additional copyright notices or restrictions contained in the Service.

4. Restrictions on Use

You may not use the Service for any illegal purpose or in any manner inconsistent with the TERMS. You agree to use the Service solely for the use and benefit of your own organization, and not for resale or other transfer to, or use by or for the benefit of, any other person or entity. You agree not to use, transfer, distribute or dispose of any information contained in the Service in any manner that could compete with the business of Guy Carpenter. You acknowledge that the Service has been developed, compiled, prepared, revised, selected and arranged by Guy Carpenter and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort and money and constitutes valuable intellectual property and trade secrets of Guy Carpenter and such others. You agree to protect the proprietary rights of Guy Carpenter and all others having rights in the Service during and after the term of this agreement and to comply with all reasonable written requests made by Guy Carpenter or its suppliers of content, equipment or otherwise (“Suppliers”) to protect their and others’ contractual, statutory and common law rights in the Service. You agree to notify Guy Carpenter in writing promptly upon becoming aware of any unauthorized access or use of the Service by any party or of any claim that the Service infringes upon any copyright, trademark or other contractual, statutory or common law rights.

5. Further Restrictions on Use

You may not copy, reproduce, recompile, decompile, disassemble, reverse engineer, distribute, publish, display, perform, modify, upload to, create derivative works from, transmit or in any way exploit any part of the Service, except that you may download material from the Service and/or make print copies for use within your organization, provided that all copies retain all copyright and other proprietary notices. The analysis and presentation included in the Service may not be recirculated, redistributed or published by you without Guy Carpenter’s prior written consent. Modification of the Service’s content would be a violation of Guy Carpenter’s copyright and other proprietary rights. Additionally, you may not offer any part of the Service for sale or distribute it over any other medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet without the prior written consent of Guy Carpenter. The Service and the information contained therein may not be used to construct a database of any kind. Nor may the Service be stored (in its entirety or in any part) in databases for access by you or any third party or to distribute any database services containing all or part of the Service. You may not use the Service in any way to improve the quality of any data sold or contributed by you to any third party. Furthermore, you may not use any of Guy Carpenter’s names or marks in any manner that creates the impression such names or marks belong to or are associated with you or imply any endorsement by Guy Carpenter, and you acknowledge that you have no ownership rights in and to any of these names or marks. You will not use the Service, the information contained therein or any of Guy Carpenter’s names or marks in unsolicited mailings or spam material and will not spam or send unsolicited mailings to any person or entity using the Service.

6. License

You acquire no rights or licenses in or to the Service and materials contained therein other than the limited right to utilize the Service in accordance with the TERMS.

7. Rights Reserved

All present and future rights in and to trade secrets, patents, copyrights, trade names, trademarks, service marks, databases, know-how and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, including rights in and to all applications and registrations relating to the Service (the “IP Rights”) shall, as between you and Guy Carpenter, at all times be and remain the sole and exclusive property of Guy Carpenter. All present and future rights in and title to the Service (including the right to exploit the Service and any portions of the Service over any present or future technology) are reserved to Guy Carpenter.

8. Disclaimer and Limitation of Liability

You agree that your use of the Service is at your sole risk and acknowledge that the Service and anything contained therein, including, but not limited to, content, services, goods or advertisements (the “Items”) are provided “AS IS” and that Guy Carpenter makes no warranty of any kind, express or implied, as to the Items, including, but not limited to, merchantability, noninfringement, title or fitness for a particular purpose or use. Guy Carpenter does not warrant that the Service is compatible with your equipment or is free of errors or viruses, worms or “Trojan horses” and is not liable for any damage you may suffer as a result of such destructive features. You agree that Guy Carpenter, its Suppliers and its third-party agents shall have no responsibility or liability for: (i) any injury or damages, whether caused by the negligence of Guy Carpenter, its employees, subcontractors, agents, Suppliers or otherwise arising in connection with the Service; or (ii) any fault, inaccuracy, omission, delay or any other failure in the Service caused by your computer equipment or arising from your use of the Service on such equipment. The content of other Web sites, services, goods or advertisements that may be linked to the Service is not maintained or controlled by Guy Carpenter. Guy Carpenter is therefore not responsible for the availability, content or accuracy of other Web sites, services or goods that may be linked to, or advertised on, the Service. Guy Carpenter does not: (a) make any warranty, express or implied, with respect to the use of the links provided on, or to, the Service; (b) guarantee the accuracy, completeness, usefulness or adequacy of any other Web sites, services, goods or advertisements that may be linked to the Service; or (c) make any endorsement, express or implied, of any other Web sites, services, goods or advertisements that may be linked to the Service. Guy Carpenter is also not responsible for the reliability or continued availability of the telephone lines and equipment you use to access the Service. You understand that Guy Carpenter and/or third-party contributors to the Service may choose at any time to inhibit or prohibit their content from being accessed under the TERMS.

9. Limitation of Liability

UNDER NO CIRCUMSTANCES, INCLUDING, BUT NOT LIMITED TO, NEGLIGENCE, SHALL GUY CARPENTER, ITS SUPPLIERS OR ITS THIRD-PARTY AGENTS BE LIABLE TO YOU OR ANY THIRD PARTY FOR DIRECT, INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL, PUNITIVE OR EXEMPLARY DAMAGES EVEN IF AN AUTHORIZED REPRESENTATIVE OF GUY CARPENTER HAS BEEN ADVISED SPECIFICALLY OF THE POSSIBILITY OF SUCH DAMAGES, ARISING FROM USE OF OR INABILITY TO USE THE SERVICE OR ANY LINKS OR ITEMS ON THE SERVICE OR ANY PROVISION OF THE TERMS, SUCH AS, BUT NOT LIMITED TO, LOSS OF REVENUE OR ANTICIPATED PROFITS OR LOST BUSINESS. (Applicable law may not allow the limitation or exclusion of liability or incidental or consequential damages.)

10. Representations and Warranties

You represent, warrant and covenant that you: (i) have the power and authority to enter into this agreement; (ii) are at least eighteen (18) years old; (iii) shall not use any rights granted hereunder for any unlawful purpose; and (iv) shall use the Service only as set forth in these TERMS.

11. Indemnification

You agree, at your own expense, to indemnify, defend and hold harmless Guy Carpenter and its employees, representatives, Suppliers and agents, against any claim, suit, action or other proceeding, to the extent based on or arising in connection with your use of the Service, or any links on the Service, including, but not limited to: (i) your use or someone using your computer’s use of the Service; (ii) a violation of the TERMS by you or anyone using your computer; (iii) a claim that any use of the Service by you or someone using your computer infringes any IP Right (as herein defined) of any third party, or any right of personality or publicity, is libelous or defamatory, or otherwise results in injury or damage to any third party; (iv) any deletions, additions, insertions or alterations to, or any unauthorized use of, the Service by you or someone using your computer; or (v) any misrepresentation or breach of representation, warranty or covenant made by you contained herein. You agree to pay any and all costs, damages and expenses (including reasonable attorneys’ fees) and costs awarded against or incurred by or in connection with or arising from any such claim, suit, action or proceeding.

12. Termination

Either you or Guy Carpenter may terminate this agreement with or without cause at any time and effective immediately. You may terminate by discontinuing use of the Service and destroying all materials obtained from the Service. This agreement will terminate immediately without notice from Guy Carpenter if Guy Carpenter determines, in its sole discretion, that you have failed to comply with any provision of these TERMS. Upon termination by you or upon notice of termination by Guy Carpenter , you must promptly destroy all materials obtained from the Service and any copies thereof. Sections 2, 3, 4, 5, 8, 9, 11, 12, and 13 shall survive any termination of this agreement.

13. Governing Law

These TERMS shall be governed and construed in accordance with the laws of the United States of America and the State of New York, without giving effect to conflicts-of-law principles thereof. You agree to submit to the personal jurisdiction of the state and federal courts located in New York County with respect to any legal proceedings arising out of this agreement and waive any objection to the propriety or convenience of venue in such courts. If any provision of the TERMS is found by a court of competent jurisdiction to be invalid or unenforceable, such provision shall be enforced to the maximum extent permissible and the other provisions of the TERMS shall remain in full force and effect.

14. Access Outside the United States

If you choose to access the Service from outside the United States, you are responsible for compliance with foreign and local laws. Software from the Service may be subject to United States export controls that prohibit downloading, exportation or re-exportation: (i) into (or to a national or resident of) Cuba, Iraq, Libya, Iran, Syria, Sudan, or any other country to which the U.S. has embargoed goods; or (ii) to anyone on the U.S. Treasury Department’s Table of Deny Orders. By using the Service, you represent and warrant that you are not located in, controlled by or a national or resident of any such country or on any such list.

15. Miscellaneous

You acknowledge that Guy Carpenter has the right to change the content or technical specifications of any aspect of the Service at any time at Guy Carpenter’s sole discretion. You further accept that such changes may result in your being unable to access the Service.

16. Official Correspondence

Official Correspondence must be sent via postal mail to: Guy Carpenter & Company, LLC, 1166 Avenue of the Americas, New York, NY 10036, Attn: Legal Department.