Sponsors are reacting to the market’s minimum return requirements by increasing the risk profiles of the transactions they place. This year, the median year-to-date expected loss is the highest in the market’s history, even exceeding 2006 (which was influenced by the active 2004 and 2005 hurricane years). With the availability of leverage down — and its cost up — investors are looking at transactions more carefully in order to meet their return targets. Investors, effectively, are willing to accept (and in some cases actively seeking) transactions with embedded leverage (via multi-peril, multi-zone exposures) for peak risks to meet return hurdles. In an environment in which financial leverage is plentiful and cheap, investors (particularly the dedicated catastrophe funds) should be more inclined to build portfolios with composed of diversified perils and more remote risk profiles — which carry lower coupons — as it is easier to borrow against a book that is stable (i.e., less total exposure to a single event or peril) and carries less risk.
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