Catastrophe Bond Market Development Accelerates in Europe
January 6, 2022 — London
Catalysts include the non-correlated nature of returns and the likelihood of more extreme weather
Europe’s catastrophe bond market looks set to continue growing on the back of protection buyers seeking risk transfer from capital markets and strong investor demand, according to the latest issue of The Cerulli Edge―Global Edition.
The catastrophe bond market has become much deeper in recent years, with a number of new sponsors bringing bonds to the primary market, according to the research. Furthermore, the cost of issuance is expected to get cheaper thanks to innovation and technology.
“With new catastrophe bond sponsors entering the market and traditional players still needing to issue in order to risk manage their books after several years of losses, there is an expectation that growth will be accelerated by interest in regions where large protection gaps remain,” says Justina Deveikyte, director of European institutional research at Cerulli.
As a floating-rate security, catastrophe bonds are positioned to benefit from a rising interest rate environment. There has been strong demand, particularly within the catastrophe bond UCITS fund space, as European investors seek positive-yielding strategies. With the frequency of extreme weather events increasing as a consequence of climate change, the World Economic Forum estimates that the market in catastrophe bonds could be worth US$50 billion by the end of 2025. The European Central Bank referred to the growth of this market in its November 2021 financial stability review, stating that these bonds offer significantly uncorrelated and relatively high returns. It added that investors prefer the more liquid, transparent, and better understood nature of cat bonds over other segments of the insurance-linked securities (ILS) market that deal with the greater uncertainty of secondary perils.
Catastrophe bond and ILS issuance in 2021 was boosted by record levels of mortgage and private ILS deals. With insured losses from natural disasters hitting US$40 billion in the first half of this year, it is inevitable that interest in options for protection from this growing financial risk will rise further. Investing directly in these vehicles, however, requires a high level of expertise and some of the structures are quite complex, exhibiting multiple perils, territories, and triggers.
Catastrophe bonds allow insurance companies to transfer the risk of natural disasters covered by their policies to investors. The money raised with these bonds is set aside to cover potential losses. If the triggers spelled out in the contract are met, the insurer gets to use the money to offset what it has paid out to policyholders and no longer has to repay the holders of the bond. If the natural disasters covered by the bond do not occur, the investors get their money back in full when the bond matures and also collect regular interest payments.
Catastrophe bonds typically underwrite more remote risk than traditional segments of the reinsurance market, as has been shown by the resilient performance through 2017, 2018, and 2020 to 2021. They are typically three to five years in tenure, which helps limit large environmental and climate changes over a bond’s life. Models are also updated regularly, and most catastrophe bonds feature variable annual resets which will capture this changed risk profile.
- Life insurers in Asia continue to seek yields and portfolio diversification by boosting their alternative assets, but some are taking a gradual approach instead of rapidly raising their allocations. Insurers are weighing the benefits against the costs of high-risk capital charges imposed by solvency rules in various jurisdictions.
- The COVID-19 pandemic has changed U.S. institutional business development and will continue to do so. Institutional sales and marketing efforts will likely need to be recalibrated. Individual firms will have to look at their current marketing programs and sales tactics and determine how effective they will remain with remote work models.
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