Financing Catastrophes

Yesterday we cited projections of increasing catastrophe losses in years to come along the Atlantic and Gulf Coasts, so today we turn our attention to the topic of how to finance catastrophic risk. Historically the capacity to finance such risk was limited to the traditional re/insurance markets, or to self-insurance and pooling. Now insurers can diversify their risk and expand the availability of insurance in cat-prone areas by tapping into the capital markets. An article by Michael Lewis in the New York Times magazine on Sunday August 26 focuses on this very topic and describes one well-known capital markets solution: catastrophe bonds. Catastrophe bonds developed in the wake of mega-cats Hurricanes Andrew and Iniki in 1992 and the Northridge earthquake in 1994. Since then, cat bonds have been used to cover a wide variety of exposures, with earthquakes (both U.S. and Japan) and U.S. hurricanes accounting for the majority of bond issues. Without question, the market for natural catastrophe bonds is growing. Guy Carpenter reports that annual issuance of cat bonds reached a record $4.69 billion in 2006, up 136 percent from $1.99 billion in 2005. The number of transactions completed also doubled to 20 in 2006, from 10 in 2005. However, despite recent gains, over the longer-term the dollar value and number of catastrophe securitization transactions is still modest in relation to global reinsurance capacity. Between 1997 and 2006, 89 catastrophe bonds  were completed, representing $15.35 billion in catastrophe bond issuance, relative to $330 billion in global reinsurance capacity. What do you think? Check out further I.I.I. info on reinsurance and alternative risk financing options.

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