Hurricane Sandy may have devastated the Jersey shore, but it
didnt dampen investor interest in high-yielding
catastrophe bonds. The market for natural disaster cat
bonds, which property and casualty insurers issue to
transfer risk, just had its best year for new issuance since
2007 thanks to a strong fourth quarter, though some older bonds
with exposure to Sandy may end up getting nicked for some of
The first deal after Sandy, from insurer USAA in November,
covers a range of U.S. perils, including hurricanes, severe
thunderstorms, earthquakes, winter storms and California
wildfires. The company increased the offering from $250 million
to $400 million in response to demand from investors. It was
able to do so even though Standard & Poors Corp. had
put two of the earlier bonds in USAAs Residential
Reinsurance series, from 2011 and earlier in 2012, on
CreditWatch with negative implications because of potential
losses from Sandy.
The successful Residential Re 2012-2 placement
post-Sandy was a very good sign, says William Dubinsky,
the head of insurance-linked securities at Willis Capital
Markets & Advisory, the investment banking arm of the
global insurance broker. That kind of deal, with those kinds of
risks, is the bread and butter of the natural
disaster catastrophe bond market, he says.
Last year companies issued a total of $5.9 billion in bonds
in the natural disaster category, bringing the total amount of
outstanding natural disaster cat bonds to $15.2 billion
globally. Overall, cat bond issuance, including a much smaller
market segment devoted to pandemic and mortality risk, was
slightly more than $6 billion.
Last years natural disaster bond issuance was up by
37.2 percent from 2011s $4.3 billion. Dubinsky says 2013
should be even stronger. The pipeline that were
aware of is pretty good, he says.
Still, the size of the cat bond market remains small.
Outstanding debt totals $36 billion once private placements are
included, with the U.S. accounting for over a third of that.
Thats roughly equal to the amount of reinsurance premiums
taken in by just one company, market leader Munich Re, in
Then again, the market for cat bonds is relatively new. The
first natural catastrophe bond was issued in 1996. In the wake
of Hurricane Andrew in 1992 and the Northridge earthquake in
Los Angeles in 1994, insurers started thinking about new ways
of raising additional capital to cover truly extraordinary
The money raised by a cat bond is held in a trust and earns
interest typically, for three years, though some bonds
mature in as little as one. That money is the last to be tapped
should the claims from an event exhaust all of the usual lines
of insurance and reinsurance. Its rare, but it does
happen that investors lose some of or their entire principal.
The Japanese earthquake in March 2011 wiped out a $300 million
Japanese earthquake bond, issued by Muteki for Japanese insurer
Zenkyoren in May 2008. In 2011, two $100 million bonds, issued
by Mariah Re in 2010 on behalf of Wisconsins American
Family Mutual Insurance Co. to cover severe U.S. thunderstorms,
were also total losses for their investors.
Its pretty unusual that investors will buy a bond
knowing that they risk a loss of principal. Most
investors are more comfortable analyzing the longevity of a
CEOs tenure or the vagaries of a product introduction
than they are looking at the statistical properties of natural
catastrophes, says John Brynjolfsson, chief investment
officer at Armored Wolf, the $781 million-in-assets investment
advisory firm based in Orange County, California. So why is the
A big part of the allure of cat bonds is their rates, which
range from 3.5 percentage points to more than 20 points over a
base rate such as LIBOR or U.S. Treasury yields, says Luca
Albertini, chief executive officer of Leadenhall Capital
Partners, a London-based investment management firm that has
$857 million invested in natural disaster and mortality risk
bonds and private placements. The average yield spread on a cat
bond is about eight or nine points, he says. Some cat bonds go
as high as plus 22 percent, but, Albertini says,
Unless you are an aggressive risk taker, you dont
want that bond because a rate that high indicates a level
of risk out of the ordinary. Because of the risk of
attachment that is, the risk that the
bonds principal will be tapped, in whole or in part, to
pay claims cat bonds are not rated investment grade
and a consequent loss of principal, cat bonds are not rated
investment grade, but they typically offer higher coupons than
corporate junk bonds.
The biggest chunk of the market 72 percent, according
to Willis is exposed to U.S. wind, or
hurricane, risk. Other perils such as European wind or
Japanese earthquake carry lower coupons closer to 4 or 5
percent because of demand from investors who want to
diversify with transactions that are not exposed to U.S. wind
and quake, Albertini says. Deals can also include
multiple tranches with ascending levels of risk and return. For
instance, that USAA Reinsurance Re deal from November had four
tranches. The first two, with the lowest risks of attachment,
closed at 4.5 percent and 5.75 percent, according to Artemis,
an online site for the reinsurance industry that maintains a
deal directory. The other two
tranches, which have a higher probability of attachment, closed
at 12.75 percent and 19 percent, Artemis said.
Since there is that risk of total loss, cat bonds in the
U.S. are sold only to accredited investors as 144A offerings.
Most institutional investors invest via managed funds, where
the risks are diversified geographically and by the type of
peril. The funds may also diversify by including private
placements, in addition to bonds.
So far, none of the cat bonds have been triggered by Sandy,
but Albertini says that his funds paid out a small amount,
mainly on bilateral private transactions. Because of SEC
restrictions on advertising the returns on these kinds of
funds, he says he cant be more explicit, but he says
industry-wide, no one had double-digit losses, so far as
When Sandy first hit, a group of bonds traded down in the
market because of the fear of losses. By now, most have
rebounded, with just a few still trading at significant
discounts, including one of the USAA bonds and a Swiss Re
issue, the Successor Class V F4 bonds, maturing in
November 2015, which market sources say is still trading in the
Sandy is seen as being much less devastating at least
from the insurance perspective than Hurricane Katrina.
Thats because much of the damage from Sandy was caused by
flooding in coastal areas, which usually isnt covered by
private insurance, but by the federal government via the
National Flood Insurance Program. Private coverage for
hurricane damage typically covers the damage caused by wind,
but not water.
There are a number of preliminary estimates from risk
modeling agencies on the losses from Sandy, but the estimate
that everyone in the industry considers to be the most
definitive is from PCS, or Property Claim Services, which is
based on on the ground reports from insurers on
their actual losses. The day after Thanksgiving, PCS issued its
first estimate on losses from Sandy at $11 billion. That number
will be updated in mid-January, and there will be continual
updates after that. By way of comparison, PCS initial
estimate on Katrina was $34.4 billion, and the final number,
issued almost two years later, was $41.1 billion.
Katrina caused substantial wind damage the kind that
insurers pay for throughout a large area that included
not only New Orleans and Mississippi but also Alabama and
northern Tennessee, explains PCS assistant vice president Gary
Kerney, based in Jersey City, New Jersey.
Sandy will take longer to sort out, he says, because access
to many areas along the Jersey shore remains restricted, making
it difficult for adjustors to do on-site inspections. At
this point in time, theres still an awful lot thats
unknown, he says. It will be a real challenge to
come up with a final number.
The consensus in the industry is that if the actual losses
from Sandy hit $20 billion, more cat bonds would be in danger
of taking a hit. Albertini says he would be stunned
if PCS rose beyond $17 billion to $18 billion.
But the risk modeling agencies think that higher insured
losses are within the range of probability. AIR Worldwide,
which issued an initial estimate of $7 billion to $15 billion,
raised its estimate to $16 billion to $22 billion in late
November, according to Artemis, The site also reported that
EQECAT, another risk modeling agency, had doubled its initial
estimate, from $5 billion to $10 billion, to $10 billion to $20
billion, while RMS estimate stood at $20 billion to $25
billion. Most recently, reinsurance broker Holborn projected a
range of $20 billion to $30 billion in insured losses
the highest estimate so far, Artemis said. Reinsurers,
and also cat bond investors, must be watching and wondering
where this will end, Artemis said.
With additional reporting by David Turner.