Reinsurers pull back cat reinsurance coverage, cat bonds & ILS instruments

Following multiple years of large catastrophe losses, reinsurers are raising prices and pulling back cat reinsurance coverage. This puts the cat bond market in a favourable position to provide the large amount of risk capital needed to cover the most damaging global catastrophes, according to a report from DBRS Morningstar.

It expects a moderate decrease in cat bond issuances in H1 2023 following the rapid rise in interest rates.

However, sustained demand for cat risk transfer should support a return to the trend of strong volume growth observed in the last 20 years.

While P&C insurers have generally performed well in recent years, catastrophe experience has been challenging for the industry as 2022 marked the second consecutive year where global catastrophe insured losses exceeded $100 bn.

Most reinsurers have responded by substantially increasing rates for cat coverage, with some going even further and reducing exposure to problematic lines.

Cat bonds and other alternative risk transfer instruments may have a greater role to play going forward as reinsurers restrict coverage and additional sources of risk absorbing capital are needed.

Despite the uncertain issuance environment going into 2023 with rising interest rates, cat bonds are expected to continue to absorb a growing share of the cat risk over time as traditional reinsurers are unwilling or unable to provide the capacity needed by direct writers.

Cat bonds have become a popular medium of transferring catastrophe risk given their advantages in current environmental and economic conditions.

In addition to opening up a new source of capital to help mitigate high claim payouts, cat bonds have also allowed insurers to obtain reinsurance coverage in a flexible and transparent way.

What is an example of a catastrophe bond?

Catastrophe bonds are typically used by insurers as an alternative to traditional catastrophe reinsurance. For example, if an insurer has built up a portfolio of risks by insuring properties in Florida, then it might wish to pass some of this risk on so that it can remain solvent after a large hurricane.

Who issues catastrophe bonds?

In general, CAT bonds are issued by three different types of institutions: insurance companies, reinsurers, and state catastrophe funds. These three types of institutions employ CAT bonds in their own distinctive ways to offload their specific insurance risks.

What is the catastrophe bond market?

A catastrophe bond is a debt instrument that allows the issuer to get funding from the capital market, if and only if catastrophic conditions, such as a hurricane, occur. Climate change is expected to increase the likelihood and severity of these extreme weather events.

Are cat bonds risky?

CAT bonds can risk of losing the principal amount invested if payment to the insurance company occurs. Natural disasters can occur during stock market declines and recessions, which in turn could negate the diversification benefit of CAT bonds.

Who buys catastrophe bonds?

Most retail investors don’t commonly buy cat bonds. Instead, catastrophe bond investors are generally hedge funds, pension funds, and other institutional investors. Some mutual fund companies invest in cat bonds by tracking an underlying index like the Swiss Re Cat Bond Performance Index.

by Nataly Kramer