NEW YORK–Catastrophe bond market activity is set to fall from a lofty peak of $4 billion in issuances in 2006, but the market will remain strong in 2008 and move in different directions, experts said here.

During the opening session of the “Standard & Poor's Insurance-Linked Securities Conference” last week, Rodney Clark, managing director of S&P's Financial Institutions group, noted that the level of issuance for bonds linked to natural catastrophes jumped to over $4 billion in 2006 from just over $1.5 billion in 2005–with the U.S. hurricane events of 2005 driving the boost in activity.

With such hurricanes becoming a more distant memory in 2007, the issuance level fell to about $3.8 billion last year, he said. (The figures he cited only include catastrophe bonds rated by S&P.)

An even lower level is expected in 2008, because of better availability of reinsurance, Mr. Clark said. “When reinsurance is cheap, cat bonds are not economically efficient,” he said, noting, however, that S&P believes the cat bond market “will still be strong over the long term.”

Supporting his view on the long-term strength of the market, Mr. Clark noted that bonds linked to risks other than U.S. hurricanes–the most popular peril used as a cat bond trigger to date–have recently come into the market. For example, he noted that S&P gave ratings for a cat bond linked to Mexico earthquake risk in 2006 and to a UK flood bond in 2007.

Shiv Kumar, managing director of Goldman Sachs & Co., noted that recent deals have also included other catastrophes risks like wildfires, tornado and hail.

Mr. Kumar and Jonathan Spry, senior vice president of Guy Carpenter, said they believe other insurance risks can also be linked to securities, including Caribbean offshore energy, adverse loss development, workers' compensation catastrophes, satellite launch failures and risks associated with reinsurance recoverables.

Bonds covering business interruption risk could even be in the offing, said Beat Holliger, managing director for Munich Re Capital Markets, who gave an example of a deal he worked on last year for a Japanese railway company. “In the Japanese market, business interruption is not available in sizable amounts. So the client was looking for new ways to buy protection against loss of operations,” he said.

Likening the exposure contemplated to a property loss that could shut down Grand Central Station in the United States, he explained that the Japanese railway company was thinking beyond the property damage and looking for coverage for the risk of not being able to sell tickets.

Mr. Kumar said it is possible to securitize any risk with a credible loss distribution. (A loss distribution is essentially a model that links loss amounts to their probability of occurring.)

Mr. Spry agreed, noting that “the state of the art in catastrophe modeling is a key driver” of cat bond innovation.

Participating on a panel of cat modeling experts, Peter Nakada, managing director of RMS Consulting, noted that investors love securities involving new perils, because they seek to diversify their portfolios.

On the issuer side, however, there is much less impetus to issue bonds for “perils that are not peak,” he said, referring to peak perils as the ones for which insurers need more capacity.

“Having said that, we certainly have seen some interest in areas like China and India,” he said, adding that he has fielded inquiries with respect to his firm's earthquake models for those regions. “So you may see some of those coming down the pike,” he said.

As for the ultimate level of cat bond activity in 2008, Mr. Kumar and Mr. Holliger said that while levels are falling, deals maturing and in the pipeline indicate to them that the total issuances won't dip too far below $4 billion.

Special Reports /

Cat Bond Market Weakens As Reinsurance Rates Drop

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