Property catastrophe reinsurance is causing a feeding frenzy forinvestors as they seem extremely willing to plunk their money intoan alternative investment that does not correlate with their otherportfolio bets.

The tens of billions of dollars flowing into the reinsuranceindustry are being funneled into securities including catastrophebonds and other insurance-linked reinsurance investments. Thisbountiful capacity augments traditional sources in the venerablereinsurance industry, although even reinsurers are creating thecollateralized securities and selling them to investors. Forbuyers—primary insurance companies the world over—the lines areblurred insofar as who is taking the reinsurance risk.

While some industry observers see the new capacity as a paradigmshift in the fundamental business of reinsurance, others point outthat catastrophe bonds have been around since the mid-1990s, notthat they represented a sea change. What makes today different fromthen is the huge interest in this investment alternative, which ispredicated, in large part, on the dismally low interest ratesoffered investors on more traditional investments like bonds.

For personal and commercial buyers of insurance, this vastreinsurance pool promises good sailing ahead, in the form ofpotentially lower pricing on a range of insurance products. Whilemany other factors come into play in primary insurers' underwritingprocesses, the ability for to pass on a portion of these risks toreinsurers at a competitively lower price is sure to have apositive effect on premiums now and into the near future.

Already, the current insurance policy renewal season is seeingthis capacity play out to the benefit of risk managers. “Absolutelythe competition all this capacity is creating in the reinsurancemarket is having an effect on pricing,” said Lara Mowery, managingdirector and head of global property specialties at reinsurancebroker Guy Carpenter. “There are a lot of factors that go into whatmakes up a reasonable, actuarially sound primary insurance price,and the costs to the insurance company to manage its overall riskprofile is certainly one of those components. For primary insurers,there is no question that this is a buyer's heaven,” she said.

Billion Dollar Gambles

Approximately $50 billion is now invested in collateralizedreinsurance securities, the lion's share in property catastrophereinsurance, according to James Vickers, chairman of reinsurancebroker Willis Re International in London. “This all started in themid-90s, but in the last year or two we've really seen asignificant influx of capital,” Vickers says.

Bryon Ehrhart, CEO of reinsurance intermediary Aon Benfield ofthe Americas in the Chicago office, estimates this volume a bitless at about $45 billion, but predicts this capacity is less thana third of what it will become. “Over the next five years, I wouldestimate that another $100 billion will flow on top of the $45billion in there today,” he projects.

Virtually all this securitized reinsurance is assembledoffshore, capitalized in Bermuda, the Cayman Islands, and otherhospitable regulatory climates. The money is secured incollateralized trusts, there for the taking when primary insurerspull in their cessions to address losses as part of theirreinsurance treaties.

Roughly 70 percent of the money in collateralized reinsurancecomes from pension funds, with the rest a mix of high net worthprivate investors, life insurance companies and endowments. There'sa sprinkling of hedge fund money and sovereign funds in there, butnothing to sneeze over, the observers contend.

Obviously these developments pose a common sense question—whywould anyone invest in the whims of Mother Nature, particularly inthe aftermath of such highly-publicized disasters as the Japanearthquake/tsunami, Superstorm Sandy, and the massive floods inThailand in 2011?

Part of the answer is the protracted low interest rateenvironment. “Following the financial crisis, interest ratesplummeted and have barely budged since, creating not much in theway of investing opportunities,” said Ehrhart. “Pension funds arefinding little to do with their money these past four or fiveyears, and this is a sector with $4 trillion in assets.Collateralized reinsurance is simply paying more than fixed incomesecurities are paying.”

Robert Hartwig, president and chief economist at the NewYork-based Insurance Information Institute, shares this view.“Pension funds and other large pools of investable cash aresearching the world over for areas in which to make investments toovercome or compensate for the low-yield environment in traditionalinvestments, such as corporate and government bonds,” Hartwig said.“Collateralized reinsurance is serving that purpose.”

Another factor explaining the robust investor interest is thetwo-decade history of catastrophe bonds, giving investors peace ofmind that this isn't some newfangled, untested financial concept.“Investors have been experimenting with catastrophe risk since1993,” said Brad Kading, president of the Association of BermudaInsurers and Reinsurers, in Hamilton, Bermuda. “Our sense is thatthe experiment is over and pension funds, in particular, havedecided this is definitely a market they want to be in.”

Finally, the lack of any correlation with other investments hasmade property catastrophe reinsurance a great diversification playfor pension funds and other investors. “You can't get away from thediversifying benefits of this class,” Vickers said. “As an assetclass, [collateralized reinsurance] is completely uncorrelated withany other form of investment.”

Hartwig concurs. “Insurance-linked securities are attractive toinvestors because they lower the volatility of a portfolio, allthings being equal,” he says. “Whatever happens to interest rates,equities or other more traditional investments, performance-wise,has nothing to do with whether or not a Class 5 hurricane hits NewYork.”

Stickiness Factor

True enough, but what if that Class 5 storm does smack into theBig Apple—will the investors stick through thick and thin? Kadingis optimistic. “In my view, they're here to stay,” he said.

He said the recent spate of large-loss natural disasters werethe key test in this regard. “Investors lost money on catastrophebonds that were underwater,” Kading explains. “Whether or not theycould live through the loss of their capital, which has nowhappened on at least two bond issues, and return (to the market)was the test. Obviously, they did.”

Hartwig is less sure the interest will remain high for allinvestors. “In a worst case scenario, meaning an economicenvironment where interest rates rose sharply higher and severallarge scale catastrophe losses triggered numerous securities forpayout, were that to happen simultaneously would some of thiscapital exit the system? Yes. Would it exit completely? No.”

Vickers seems to agree with this stance, but he says the factthis market has matured indicates it is not going away any timesoon. “The challenge really is not capacity, but demand,” he said.“Will primary insurers need more reinsurance as time goes by orpossibly less? One would think the answer is more, given theexpanding need for insurance in many emerging markets. Manygovernments are privatizing formerly government-owned businesses,which also increases demand.”

These new insurance buyers may get a deal that veteran buyersdid not—stable insurance prices immune to the industry's historic,knee-jerk market cycle. Only time will tell.