August 11th, 2010

Catastrophe Bond Update: Second Quarter 2010 – Activity Surges…Reflecting Favorable Issuance Conditions and Strong Investor Demand: Part III, Conclusion

Posted at 1:00 AM ET
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Second Quarter 2010 versus First Quarter 2010 and Second Quarter 2009
Second quarter of 2010 issuance activity increased relative to first quarter of 2010, both in terms of transaction count (eight versus six) and risk capital issued (USD2.05 billion versus USD808 million). Median transaction size was USD245.0 million in the second quarter of 2010 relative to USD125.0 million in the second quarter of 2009. Increased transaction size is due primarily to market conditions. In the first six months of 2009 spreads were at or near their all time widest levels due to lingering credit crisis concerns and expectations of an active 2009 North Atlantic hurricane season. Spread levels have tightened 20 to 30-percent year over year, due to increased systemic stability, net new inflows into catastrophe bond asset managers, maturities of outstanding bonds, and competitive pressure from the traditional reinsurance market that continues to tighten. At lower spread levels, sponsors that had reduced or even postponed their catastrophe bond transaction during the second quarter of 2009 elected to target increased transaction sizes during the second quarter of 2010.

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Risk Capital Outstanding

Over the second quarter of 2010 total risk capital outstanding declined USD105 million to USD11.82 billion as USD2.05 billion of new issuance was outstripped by USD2.16 billion of maturities. This is the second consecutive quarter of declining risk capital outstanding. An additional USD1.92 billion of risk capital is scheduled to mature prior to year-end 2010. 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 year-end 2008.

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Industry Loss Warranties

Industry loss warranty (ILW) negotiations and trading picked up significantly in the second relative to the first quarter of 2010. Reinsurers, reluctant to retain additional potential losses after catastrophe events in Chile, Australia and in offshore energy books, began looking to enhance and supplement existing reinsurance protections. Initially, this prompted a sharp increase in traded volumes in late April and May and a rate hardening of 10 percent over this time period after a sustained period of softening since early 2009. Protection buyers however, were generally able to find protection sellers at these increased rates. By mid June sustained demand from protection buyers began to outstrip available supply from protection sellers. This prompted a frenetic two week period during which it became increasingly difficult to find carriers to support even small limits at ever increasing pricing; in many cases 15 percent or more over and above the initial 10 percent increase. Based on general market trends it appears that this spike was more of a temporary dislocation rather than a sustained widening, as more recently, final “pre-season” deals have been successfully bound. Heading into the third quarter market attention will shift to LiveCat trades.

Outlook for Third Quarter and Remainder of 2010

The issuance outlook for the third quarter is light. The third quarter has historically been a time of retrospective evaluation and strategic planning (rather than transaction activity) for both the traditional reinsurance market and the catastrophe bond market. Both sponsors and investors tend to take stock of their positions after the June and July 1st renewals and the market generally takes a step back to digest pricing and capacity conditions after a significant renewal period. Primary catastrophe bond issuance is consistently lightest during the third quarter as market participants (primarily sponsors, who must shoulder significant non-recoupable transaction structuring expenses) are reluctant to bring a new deal to market that could be disrupted by a North Atlantic hurricane event. In early September, with greater clarity on the U.S. wind season, market participants gather in Monte Carlo, a meeting which tends to pre-sage additional catastrophe issuance during the fourth quarter of the year.

Appetite for non-U.S. wind exposed transactions is robust, as investors have investable cash on hand seeking diversifying transactions. Notwithstanding the transaction activity of the second quarter, core investors remain focused on the available supply of heterogeneous transactions to enable more balanced portfolio construction and contribute to greater market liquidity levels. Discussions concerning U.S. earthquake, European windstorm, Japanese earthquake and windstorm and other global peak peril transactions are actively ongoing. General sponsor “buy-in” on the value sourcing a portion of their risk transfer needs from the catastrophe bond market continues to increase. Spread levels for potential late third and fourth quarter transactions will be influenced by U.S. wind (and other worldwide catastrophe) activity during July and August. Currently, notwithstanding a record setting USD22 billion (3) of insured losses associated with catastrophe events occurring in the first half of 2010, traditional reinsurance markets continue to tighten with U.S. property catastrophe rates decreasing 10 to 15 percent for July 1st renewals. Provided the catastrophe bond market can remain generally competitive with other risk transfer alternatives second half issuance of USD1.70 billion to USD3.70 billion should be achievable.

[3] Source: Munich Re

Catastrophe Bond Update: Second Quarter 2010 – Activity Surges…Reflecting Favorable Issuance Conditions and Strong Investor Demand: Part I >>

Click here to read Catastrophe Bond Update: Second Quarter 2010 – Activity Surges…Reflecting Favorable Issuance Conditions and Strong Investor Demand: Part II >>

Click here to view other GCCapitalIdeas.com stories on catastrophe bonds >>

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

ILW market commentary provided by
• Barry Law, Managing Director (Guy Carpenter London)
• Larry Rothstein, Vice President (Guy Carpenter London)

*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.

**Registered Representatives of MMC Securities Corp.

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