Editor's Note: Gary Kerney is assistant vice president, Property Claim Services (PCS), a member of 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 their origin—an exercise in innovation itself—through the development of new triggers and diverse structures, these instruments have brought increased capital flexibility to the insurance and reinsurance industry. To be successful, however, innovation must remain a practical matter, addressing the needs of a wide range of carriers.

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

1. Transaction diversity: Last year, individual catastrophe bonds provided protection from a variety of perils and in multiple regions. And the combinations were more innovative than ever. One, Mythen Re, provided cover for U.S. hurricane (using the PCS Catastrophe Loss Index) and UK extreme mortality. Another transaction, Combine Re, provides cover to two carriers. While U.S. wind remains the most common region and peril for catastrophe bonds, sponsors are clearly open to exploring other ways to use these instruments, and non-U.S. perils are becoming more common. Expect that to continue, especially given the high levels of catastrophe activity around the world over the past five years.

2. Investor demand: Already high, investor interest in the catastrophe bond space continues to surge—thanks to both the yields available and the fact that these instruments are not correlated with broader financial markets. For now, at least, available capital is greater than deal flow can satisfy. In the first two months of 2013, low issuance activity has made the situation even more acute, a situation that should ease somewhat if issuance levels catch up to full-year forecasts. This supply/demand trend is likely to continue until market participants devise solutions to existing structural barriers (such as the lack of standardization in the market).

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

4. New entrants: A number of sponsors debuted in 2012, including two publicly managed entities—Citizens Property Insurance Corporation (CPIC) and Louisiana Citizens—the former sponsoring the second-largest transaction in the market's history at $750 million. The value of these transactions became apparent quickly. For Louisiana Citizens' Pelican Re, the close call with Hurricane Isaac demonstrated the need for—and viability of—that form of protection. The cost savings realized by CPIC in sponsoring Everglades Re, not to mention the capital flexibility such flexibility affords, was likely a factor in CPIC's return to the catastrophe bond space this year—CPIC is reported to be planning a $250 million transaction ahead of the June 1, 2013, Florida reinsurance renewal.

5. Market growth: Despite the prevailing structural constraints, the catastrophe bond market should continue to grow—the only question appears to be the degree. Catastrophe bond market participants should consider last year's rapid growth—38 percent, according to PCS Year-End 2012 Catastrophe Bond Report: Meeting Expectations —within the broader context of the heights it reached in 2007, with the subsequent global financial crisis and recovery of the sector. In a sense, the catastrophe bond market is just getting back to where it should have been. To attain substantial future growth, the sector will need more than increased issuance activity from existing players. Instead, we'll need to see a larger and more varied sponsor base, including smaller and midsize carriers.

The top trends in the catastrophe bond market show that continued efforts to innovation will attract more sponsors—and more capital—as past innovation has brought measurable results to the insurance and reinsurance industry. Two types of trends characterize this market: need and opportunity. Practical innovation—the hallmark of the catastrophe bond sector—will continue to support overall market growth by helping carriers transfer risk and manage their capital more effectively.

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

Special Reports /

Top 5 Catastrophe Bond Market Trends

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