Insurance-Linked Investments: Appetite for catastrophe


Investors cannot get enough of the catastrophe bond market, writes Charlotte Moore, but the potential for equilibrium, albeit at lower returns, is there

The global financial crisis highlighted the advantages of investing in catastrophe bonds to the pensions industry. All other risk assets proved to be strongly correlated in the turmoil but these insurance-linked securities, which provide protection from extreme weather and earthquake events, remained immune from the shockwaves. They also generate a decent return, making them very attractive to institutional investors.

“Since January 2002 to February 2013, the Global Swiss Re Cat Bond index has generated a compound annual growth rate of 8.9%, with very little volatility,” says Judith Klugman, head of ILS distribution and sales at Swiss Re.

Eurozone breakup could impact catastrophe bonds and insurance-linked securities


Just how uncorrelated catastrophe bonds and insurance-linked securities are with the wider financial markets is a point worth considering. We’re currently living in a time of unprecedented financial and economic upheaval due to the Eurozone sovereign debt crisis and U.S. economic issues, with many countries now officially in deepening recessions and the very real spectre of a country exiting the Eurozone a growing possibility. Of course, as any sensible observer realises, no financial instrument can be truly uncorrelated from market impacting events of this size.

In their latest quarterly ILS market report, Aon Benfield discuss the Eurozone crisis, and its impact on the insurance, reinsurance and cat bond / ILS markets. They note that contrary to the widely held thought that cat bonds and ILS are as uncorrelated a financial instrument as you can invest in, in the case of a Eurozone breakup, the catastrophe bond and ILS market will not be immune and there would be direct impacts.

European sovereign debt, U.S. default and the catastrophe bond market


With the world experiencing turbulent times economically this year including the concerns over European sovereign debt and the spectre of the U.S. government debt ceiling being breached effectively putting the U.S. into a default position, we felt it was time to ask one of the rating agencies whether they felt there was likely to be any impact on the catastrophe bond market.
The risks posed by sovereign debt issues are currently the main source of concern for the insurance and pension sectors in Europe according to the recent financial stability report published by the European Insurance and Occupational Pensions Authority. They say that the extent of the impact of sovereign debt will depend on the ability of nations globally to lower the debts towards more sustainable levels.

With an issue the size of sovereign debt there is bound to be a knock on effect for the re/insurance industry and also for the capital markets. We’ve already seen some investors dumping Eurobonds and attempting to move into safer assets. Obviously insurance-linked securities and more accurately catastrophe bonds offer one of the best alternative investments for investors seeking a safe harbour and this is likely at least part of the reason for high demand from investors recently.