No Explosive Growth Yet, But Risk-Linked SecuritiesRemain Viable Option The New York-based Bond MarketAssociation is holding its annual risk-linked securities conferencethis week, and one of the topics on the meeting's agenda will bethe growth of insurance securitization.

The discussion comes at a time when the market for risk-linkedsecurities–whose most common transaction type is catastrophe-linkedbonds used by insurers to transfer risks–has not yet taken off asmany had predicted.

But nonetheless, the market has shown a steady growth in thelast few years and remains a viable complement and even analternative to the traditional reinsurance arrangement, industryexperts said.

“The market has done fairly well with a few billion dollarsworth of issuance every year. However, there are a number ofreasons why the market hasn't exploded,” said Jayan Dhru, amanaging director at Standard & Poor's Ratings Services in NewYork.

One of the reasons is that until a couple of years ago,reinsurance rates were soft, which made it difficult for capitalmarkets to compete with reinsurance rates, Mr. Dhru toldNational Underwriter.

And despite the recent price hardening in catastrophereinsurance, another challenge has been the fact that the investorbase in this catastrophe-linked bond market is highlyspecialized.

“Partly because we really haven't seen any significant naturalcatastrophe event in this market, we don't know how this marketwould behave post-event.

“In other words, in reinsurance you know that even if the ratesharden, there will be capacity. With catastrophe bonds, you don'tknow if investors will be there following a catastrophic event.Having said all that, activities have been growing because itrepresents an alternate source of capacity,” he said.

Mr. Dhru noted S&P expects risk-linked securities to be partof insurance companies' risk management tools. “But we are notexpecting any massive growth in this segment yet. Still, we areexpecting a steady growth,” he added.

Chris McGhee, a managing director of New York-based Marsh &McLennan Securities Corp. and chairman of the risk-linkedsecurities committee at the Bond Market Association, noted thatwhile the insurance securitization market hasn't had an explosivegrowth, there is a reasonable argument that the market has beengrowing steadily.

“We had the first multiple issuance of catastrophe bonds in1997. The market has been growing steadily since then. There havebeen a total of almost $6 billion of catastrophe bonds issued since1997, and about $3 billion of those are currently outstanding,” Mr.McGhee told National Underwriter.

“Catastrophe bonds are a compliment to traditional reinsuranceand, in some cases, a substitute for reinsurance as well,” hesaid.

Mr. McGhee also noted that the price of reinsurance has clearlyimpacted catastrophe bonds.

“I think it's fair to say that if the catastrophe reinsuranceprice were to rise drastically, more companies would look tocatastrophe bonds as an alternative. In the area of low probabilityproperty-catastrophe reinsurance and retrocessional reinsurance,prices have been particularly hard. In these cases, cat bondscompare quite favorably in cost and in comparable capacity.” Mr.McGhee said.

“The other point to raise is that if enough capacity is notavailable from the reinsurance marketplace, then cat bonds can alsobe seen as an alternative.”

But although rate increases in traditional reinsurance can makecat bonds more attractive, the capacity of this alternative risktransfer tool can also keep the price hardening in check, Mr.McGhee added.

“My opinion is that, based on anecdotal evidence andconversations I had with insurers and reinsurers, cat bonds canwork as a constraint in the upward movement in prices ofproperty-catastrophe reinsurance,” he said.

But there remain some structural challenges that can impedefaster growth of the cat bond market, Mr. McGhee observed.

“It's fair to say that any securities offering is generallygoing to be more time-consuming than an insurance or reinsurancecontract. But nevertheless, it's worth the time when you considerpotential benefits. The real question is, 'Are cat bonds a viable,attractive alternative to reinsurance?' I think the answer is yes,”he said.

Mr. McGhee added that while insurance securitization is stillquite confined to property catastrophe risks, there could be aninteresting use in the securitization of life insurance risks.“Also, the securitization of aviation risks and credit insurance issomething that has been looked at as well,” he said.

In the current cat bond market, one of the most popular trendsis parametric deals, according to Roderigo Araya, vice president atMoody's.

“In parametric deals, the losses to investors in cat bonds aretied to the occurrence of certain events whose parameters exceedcertain thresholds–it can be a certain magnitude in cases ofearthquakes or a wind-speed in cases of hurricanes, ” Mr. Arayanoted.

The New York-based rating agency has rated four cat bond issuesworth some $900 million in 2002, and that figure hasn't changedmuch in the past three years.

“After 9/11, we expected a big growth in the cat bond market,but that really hasn't happened. Insurers could still getreinsurance at an adequate pricing,” Mr. Araya said.

He noted that one interesting issuance during last year camefrom Paris-headquartered media conglomerate Vivendi Universal S.A.,whose $175 million cat bonds will cover exposures for the company'sparks and film studios in California.

“Normally, cat bonds are issued by insurance companies andreinsurance companies. In Vivendi Universal's case, they becamepart of the company's risk management strategy,” he said.

“The Disneyland in Japan also did something similar in 1999 whenit issued cat bonds to protect against earthquakes, but we haven'tseen this type of CAT bond in a while,” he said.

For more information about the March 20 Risk-Linked SecuritiesConference, go to www.bondmarkets.com.

Reproduced from National Underwriter Edition, March 17, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.