Insurers are turning increasingly to catastrophe bonds to better manage exposure, according to a recently issued report from Standard & Poor's.

Since 1997, 69 catastrophe bonds have been issued with a total of $10.65 billion in risk limits, while about $1.9 billion worth of bonds were issued last year in ten separate transactions by nine issuers.

Nearing the first decade of existence, S&P found the bonds are becoming an increasingly attractive alternative to reinsurance as a means of insurer risk exposure.

"Demand for them has been stimulated not just by current high prices, but also by the tight terms and conditions of traditional reinsurance cover," the report said.

Steven Ader, Standard & Poor's New York-based analyst, said that in moderation catastrophe bonds can be an effective tool for managing portfolio risk.

"In the aftermath of a large-scale catastrophe, high geographic or industry concentrations are frequently exposed, which could cause a reinsurer to default if claims amount to more than its capital base, retrocession plan and capabilities can handle," Mr. Ader said.

The report said that when assessing an insurer's or reinsurer's net catastrophe exposure, S&P might assign these securities the same analytical weight as a reinsurance contract.

"However, our ultimate treatment of cat bonds is driven by how effectively issuers can demonstrate to us that they have correlated the amount of protection a catastrophe bond provides with their own catastrophe exposures," the report stated.

The report said that for investors as well as insurers, catastrophe bonds have both benefits and risks. On the benefit side, catastrophe bonds are collateralized against an issuer's default, so primary insurers do not face substantial counterparty risk.

"Because a catastrophe bond can cover multiple years, it enables a company to lock in its protection over a multiple-year period--a feature not available through the reinsurance market," the report said.

On the negative side, insurers bear tail risk, in that they could be responsible for claims that emerge after the bond period has matured, which means those claims would not be covered.

Special Reports /

Cat Bond Use On Rise, Says S&P

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