Future Brightening For CAT Bonds

NEW YORK–Catastrophe bonds and other risk securities are seeing steady growth and appear to have a bright future, said industry experts, despite opinions to the contrary that the vehicles were fated to obscurity just a few short years ago.

In a panel discussion at the Bond Market Association's Insurance and Risk Linked Securities Conference here yesterday, securities experts discussed the current state of the use of insurance securities and the drivers behind their growth.

Christopher McGhee, managing director at MMC Securities Corp., a subsidiary of the New York-based services firm Marsh & McLennan, observed that the growth in risk link securities has been slow and that “there was not a lot of interest in them” initially.

“The nay-sayers said this market would never break out,” Mr. McGhee said. “That has changed today.”

He said that according to MMC's securities figures, there has been a surge in the volume of risk securities. In large part, he said, this has been brought on by the need for capacity by insurers who suffered losses in last year's hurricanes and the requirements of rating agencies for more capital.

“There is a dramatic hunt for capacity that helped demand,” he observed.

Illustrating his point, Mr. McGhee said risk capital outstanding has grown from $4 billion in 2004 to $6 billion today–and it continues to grow.

Among the specialized areas where risk capital vehicles see growth, on the property-casualty side are the use of sidecars, or financial entities used by reinsurers to tap into the equity market, noted Shiv Kumar, vice president of Goldman, Sachs & Co.

A sidecar is a limited-term insurance vehicle in which the carrier and investors share an equal portion of the risk. It is geared toward specific risks for short-tail lines. Its popularity is driven by the ability to obtain more capacity on short notice, and by the limited life of the investment vehicle.

Mr. Kumar noted that recently there has been “explosive growth in this format.”

In 2005, $1.755 billion in sidecar transactions were issued. To-date this year, there have been $1.83 billion, he said, noting that he expects to see $5 billion or more in issuance by the end of the year.

There are set-up costs not associated with the vehicles that are attached to catastrophe bonds or other capital raising vehicles. Returns are in line with catastrophe bonds, he added, and can be slightly higher.

In the future, sidecars may see longer term maturities and flexible business plans, Mr. Kumar said. Some could go through the stock markets and expand into other insurance sectors on the non-property-casualty side.

For catastrophe securitization as a whole, MMC's Mr. McGhee explained that future products may grow in sophistication, with broad payout triggers making them more appealing to investors.

Today, securitizes are primarily tapped by hedge fund investors, but more bankers could become interested in the future, he said. A move by the banking industry into the area would “indicate a breakout in this market space,” Mr. McGhee concluded.