Though primary issuance is likely to be down relative to 2010, 2011 stands as one of the most active, innovative and robust years in the convergence market’s history. Catastrophe loss activity was significant. For the year, current estimates suggest as much as USD100 billion of global insured catastrophe related losses, making 2011 one of the costliest years on record. Notably, 70 percent of this total is associated with catastrophe events outside of the United States. As mentioned previously, the 144A catastrophe bond market also sustained principal losses during 2011. The Tohoku earthquake, which occurred off the northeast coast of Japan on March 11, 2011, caused a total loss to the USD300 million Muteki Ltd. transaction. The severe convective storm activity, which included tornadoes, hail and thunderstorms, that affected the central and southern United States during the spring and summer prompted what is now expected to be a total loss to the USD200 million Mariah Re Ltd. bonds. In addition to this loss activity, market participants contended with a host of issues. These included a controversial revision to one of the most commonly utilized US windstorm models, differing views on the implementation schedule and impact of the Solvency II regulatory framework, tumultuous global financial markets and a highly uncertain geopolitical environment.
Notwithstanding these challenges, the catastrophe risk asset class continued to expand and deepen. There is now a much more fully developed suite of investment options providing diversity in terms of preferred investment horizons, degree of portfolio customization desired, return targets, risk selection, peril and liquidity requirements. The 144A catastrophe bond market, with its depth, number of actively trading counterparties, transparency and liquidity levels, should remain the backbone of the convergence sector. However, strong investor support for differing product structures, including collateralized reinsurance, retrocession, section 4(2) private placements, and, to a lesser extent, exchange traded products, enables the capital markets to deliver increased product flexibility and lower access costs to transaction sponsors. It is also expanding the relevance of convergence sector capital in the overall catastrophe risk transfer arena. This is a trend that is expected to continue in the future.
Outlook for 2012
Looking ahead to 2012, the convergence sector appears poised for significant issuance activity. Issuance should be diverse with transactions containing exposure to peak perils of US hurricane and earthquake on broad geographic bases, as well as regional transactions. Additional transactions with exposure to European wind and Japanese perils are also expected to come to market. Further variety by risk profile, trigger type and occurrence versus aggregate transactions should also be available. Given the losses of the 2011 calendar year, it is likely that aggregate covers for severe convective storms will remain a peril of interest for both sponsors and investors despite the losses sustained by the Mariah Re tranches. Finally, as the investor base continues to evolve and demonstrate its ability to understand and price new perils, additional activity involving risks previously unsecuritized in the catastrophe bond market is also probable.
A sustained period of elevated and diverse issuance activity will no doubt be welcomed by a primed and ready investor community. Looking back at past periods of elevated issuance activity, such as the fourth quarter 2010 or the first three quarters of 2007, significant issuance totals tend to be concentrated in one peril or a small peril group. In 2007, due to the impact of model revision and the losses from the Katrina/Rita/Wilma storms, issuance was dominated by US hurricane risk. In 2010, driven by new issuers coming to market and favorable market conditions, issuance was dominated by US wind and earthquake perils offered on a combined basis. In some instances, this created a crowded deal environment in which clearing spreads were pushed upwards due to concentration and capacity issues for a particular peril, even in the context of high and increasing cash levels for investors, generally.
Ultimately, this temporal dislocation contributed to a deadweight loss for the market as sponsors did not issue as much as they would have in the context of higher prices, and investors did not get access to sufficient overall deal flow to match their cash deployment targets. With a more broad-based issuance forecast for the balance of 2011 and into 2012 coupled with sustained strong investor demand, there is reason to expect that the convergence market could be in for a banner year and should continue to serve an important role as a complementary source of capacity to the traditional reinsurance market.
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*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. 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. Cory Anger and Chi Hum are registered representatives of MMC Securities Corp.