Taiwan Issues Earthquake CAT Bond

Speaking at a press conference in New York, Susan Chang, Taiwan's vice minister of finance, explained that last year, earthquake insurance became a mandatory element of homeowners insurance for newly-bought residential properties that are financed through bank loans.

Since then, funds from the new insurance class have been pooled and co-managed by property insurers and Taiwan's finance ministry, as well as the Central Reinsurance Company, a state-controlled entity that provides traditional reinsurance. The newly issued CAT bond is designed to shoulder part of this reinsurance.

"In Taiwan, to further the soundness of Taiwan residential earthquake insurance pooling system, we chose to establish a CAT bond as a way to mitigate our risk," said Ms. Chang in her presentation.

"We have now successfully issued a Taiwan Residential Earthquake Insurance Pool CAT Bond, over a three-year term, at an amount of $100 million," she commented.

Ms. Chang also pointed out the advantages that such CAT bonds can provide: a stable and diversified source capacity and low credit risk. "We all know that reinsurance prices are fluctuating and are easily influenced by events that occur around the world, but a CAT bond can lock in pricing through a multi-year contract," she said.

"Although the CAT bond prices are slightly higher than traditional reinsurance prices, it is valuable because it helps Taiwan Residential Earthquake Insurance Pool avoid price fluctuations and stabilize risk-transferring costs."

Catastrophe bonds are securities that pay principal plus interest, explained Mark Rouck, director at Fitch Ratings in New York, "and if there is an earthquake or a triggering event above a pre-defined level, proceeds from the bond issue would be used to reimburse the deal's sponsor," Mr. Rouck explained.

"Essentially what it does is if there is a triggering event, an earthquake of a certain magnitude in this case, proceeds from the bond issue would be used to reimburse the sponsor."

Sean Mooney, chief economist at reinsurance broker Guy Carpenter, part of New York-based Marsh & McLennan Companies Inc., commented that Taiwan is tapping into this risk-linked securities to develop an alternative source of risk capital to traditional reinsurance. Marsh & McLennan Companies with Aon Corporation in Chicago and Swiss Re Capital Markets, co-managed this bond deal.

Mr. Mooney also elaborated further on comments from Ms. Chang. He noted that the Taiwanese government was attracted two benefits of issuing CAT bonds: "One was credit quality: when you purchase reinsurance from reinsurer, the payment of any claim on reinsurance is dependent on the credit of the reinsurer. That credit risk is virtually eliminated with the CAT bond because funds are placed in a trust fund," Mr. Mooney explained.

"Another issue is trying to find less volatility in price–partly because Taiwan did a three-year deal and was able to get a constant price over those three years," Mr. Mooney said.

Mr. Mooney also noted that there have been other CAT bonds issued in the Asian region. One example, he recalled, is the earthquake CAT bond issued a few years back by Disney Tokyo in Japan. "But Taiwan represents the only government agency in the world to offer a CAT bond," he said.

There are currently only four other such earthquake insurance pools in the world, he also explained. "One is the California Earthquake Authority. It considered issuing a CAT bond but replaced that risk-transfer layer with reinsurance. The other three earthquake insurance pools are in Turkey, New Zealand and Japan, and none of them has chosen to issue a CAT bond."

Mr. Rouck from Fitch also added that "from what I understand, this bond was received pretty favorably by investors. So that might lead Taiwan to consider putting another deal like this in place when this one matures."

Chris McGhee, a managing director of New York-based Marsh & McLennan Securities Corp. and chairman of the risk-linked securities committee at the Bond Market Association, had also told National Underwriter that while the insurance securitization market hasn't had an explosive growth, there is a reasonable argument that the market has been growing steadily.

"We had the first multiple issuance of CAT bonds in 1997. The market has been growing steadily since then–there has been a total of almost $6 billion of catastrophe bonds issuance since 1997, and about $3 billion of those are currently outstanding," Mr. McGhee said. "Catastrophe bonds are a complement to traditional reinsurance and, in some cases, a substitute for reinsurance as well."

Still, Mr. Rouck from Fitch added that he doesn't expect this deal to trigger a sudden interest or a round of significant issuance of CAT bonds, either in public or private sectors.

"We thought the market was really going to take off after 9/11 because reinsurance rates went up so drastically," he said. "Now, our general sense is that the market is kind of chugging along but it really hasn't grown as rapidly as we thought it would."

He observed that the market for CAT bonds, with a few billion dollars worth of issuance every year, hasn't yet exploded, but is gradually becoming more commonplace as investors are becoming more familiar with such securities.

"However, to some extent, there is still a bias against them from an investor perspective, just because these bonds tend to be somewhat complicated. And in most cases, they tend to deal with different types of risks than what a typical portfolio manager or an investor is used to looking at."