Editor's Note: Gary Kerney isassistant vice president, Property Claim Services (PCS), a memberof the Verisk Insurance Solutions group at Verisk Analytics(Nasdaq:VRSK).You can follow PCS on Twitter at@PCSnews.

Innovation is at the heart of catastrophe bonds. From theirorigin—an exercise in innovation itself—through the development ofnew triggers and diverse structures, these instruments have broughtincreased capital flexibility to the insurance and reinsuranceindustry. To be successful, however, innovation must remain apractical matter, addressing the needs of a wide range ofcarriers.

As 2013 begins, and the catastrophe bond market strives to meetanother year of high expectations, here's a look at the five mostimportant trends in this space reveals the convergence not just ofcapital but of innovation and practicality.

1. Transaction diversity: Last year,individual catastrophe bonds provided protection from a variety ofperils and in multiple regions. And the combinations were moreinnovative than ever. One, Mythen Re, provided cover for U.S.hurricane (using the PCS Catastrophe Loss Index) and UK extrememortality. Another transaction, Combine Re, provides cover to twocarriers. While U.S. wind remains the most common region and perilfor catastrophe bonds, sponsors are clearly open to exploring otherways to use these instruments, and non-U.S. perils are becomingmore common. Expect that to continue, especially given the highlevels of catastrophe activity around the world over the past fiveyears.

2. Investor demand: Already high,investor interest in the catastrophe bond space continues tosurge—thanks to both the yields available and the fact that theseinstruments are not correlated with broader financial markets. Fornow, at least, available capital is greater than deal flow cansatisfy. In the first two months of 2013, low issuance activity hasmade the situation even more acute, a situation that should easesomewhat if issuance levels catch up to full-year forecasts. Thissupply/demand trend is likely to continue until market participantsdevise solutions to existing structural barriers (such as the lackof standardization in the market).

3. Frictional costs: An average-sizetransaction of $250 million (based on 2012 data from PCS) now costsapproximately 20 basis points, down more than 50 percent over thepast five years. While this is a marked improvement, frictionalcosts do need to come down more, especially if the midmarket is tobe engaged. Today, the principal problem is the fixed-fee model,which makes smaller transactions disproportionately expensive (withthe exception of the PCS Catastrophe Loss Index, which becomesproportionately less expensive for smaller transactions).Standardization should help, but the market may also have to accepta tradeoff, at some point, between pricing and issuance volume.

4. New entrants: A number of sponsorsdebuted in 2012, including two publicly managed entities—CitizensProperty Insurance Corporation (CPIC) and Louisiana Citizens—theformer sponsoring the second-largest transaction in the market'shistory at $750 million. The value of these transactions becameapparent quickly. For Louisiana Citizens' Pelican Re, the closecall with Hurricane Isaac demonstrated the need for—and viabilityof—that form of protection. The cost savings realized by CPIC insponsoring Everglades Re, not to mention the capital flexibilitysuch flexibility affords, was likely a factor in CPIC's return tothe catastrophe bond space this year—CPIC is reported to beplanning a $250 million transaction ahead of the June 1, 2013,Florida reinsurance renewal.

5. Market growth: Despite theprevailing structural constraints, the catastrophe bond marketshould continue to grow—the only question appears to be the degree.Catastrophe bond market participants should consider last year'srapid growth—38 percent, according to PCS Year-End 2012 Catastrophe Bond Report: MeetingExpectations —within the broader context of the heights itreached in 2007, with the subsequent global financial crisis andrecovery of the sector. In a sense, the catastrophe bond market isjust getting back to where it should have been. To attainsubstantial future growth, the sector will need more than increasedissuance activity from existing players. Instead, we'll need to seea larger and more varied sponsor base, including smaller andmidsize carriers.

The top trends in the catastrophe bond market show thatcontinued efforts to innovation will attract more sponsors—and morecapital—as past innovation has brought measurable results to theinsurance and reinsurance industry. Two types of trendscharacterize this market: need and opportunity. Practicalinnovation—the hallmark of the catastrophe bond sector—willcontinue to support overall market growth by helping carrierstransfer risk and manage their capital more effectively.

Gary Kerney is assistant vice president, Property ClaimServices (PCS), a member of the Verisk Insurance Solutions group atVerisk Analytics (Nasdaq:VRSK).You can follow PCS on Twitter at@PCSnews.