GAO: Insurers Make Little Use Of CAT Bonds

By Steven Brostoff, Washington Editor

NU Online News Service, Oct. 24, 12:55 p.m. EDT, Washington?-Only a small portion of insurance company natural catastrophe risk has been transferred to the capital markets, according to a new report from the United States General Accounting Office.

The GAO, using data provided by Swiss Reinsurance Company Capital Markets, found that outstanding catastrophe bonds represented about 2.5 percent to 3 percent of worldwide catastrophe reinsurance coverage in 2002.

According to the GAO, while catastrophe bonds play an important role for some insurance and reinsurance companies, the costs associated with bonds as well as other factors have limited their use.

GAO did the report at the request of House Financial Services Committee Chairman Mike Oxley, R-Ohio, who asked GAO to identify the use of catastrophe bonds as a supplement to traditional disaster insurance and what obstacle may be deterring their growth.

The Committee held a hearing on financing of catastrophe risks last year.

Peggy Peterson, communications director for the Committee, said the inquiry into catastrophe risk financing will continue.

"In an era where we not only face the threat of natural disaster, but of terrorism, the need to seek out additional ways to increase insurance capacity is paramount," Ms. Peterson said.

"The Committee will continue in this effort, including studying ways to tap directly into the U.S. capital markets," she added.

According to the GAO report, some insurers use catastrophe bonds as a supplement to traditional ways of manage catastrophe risk, such as reinsurance and underwriting.

However, other insurance companies believe that the total costs of catastrophe bonds, which includes relatively high rates of return to investors and administrative costs, significantly exceed the costs of purchasing reinsurance, GAO said.

Meanwhile, GAO said, the Kansas City, Mo.-based National Association of Insurance Commissioners is still evaluating statutory accounting issues associated with catastrophe bonds.

For example, GAO said, NAIC has not decided whether catastrophe bonds should receive the similar accounting treatment as reinsurance under certain circumstances.

As for investors, GAO said that their view of catastrophe bonds is mixed. Some investors like catastrophe bonds because of their relatively high rates of return and because they diversify investment portfolios.

Other investors, particularly mutual funds, avoid catastrophe bonds because of the perceived risks or because they do not have the technical capacity to analyze the risks associated with these types of securities, GAO said.

In addition, some mutual funds say that catastrophe bonds lack liquidity compared with traditional investments.

As for catastrophe bonds covering terrorism risks, GAO said that none have been issued and the widespread belief is that issuing such a security would be a challenge.

One problem, GAO said, is developing statistical models to predict the frequency and severity of terrorist attacks.

While some models have been presented, GAO said, most financial market participants believe the models are too new and untested to support terrorism-related catastrophe bonds.

GAO did not issue any recommendations in its report on ways to encourage the use of catastrophe bonds.

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GAO: Insurers Make Little Use Of CAT Bonds

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