LONDON (Reuters) – The catastrophe bond sector is likely to grow by 25 percent in 2012, reaching $6-7 billion in issuance by the end of the year – matching a previous record set in 2007, investors say.
A number of new reinsurance companies backed by hedge funds have entered the market in recent months, spurring record sales of catastrophe bonds in the first half of 2012 and bringing in $3 billion of fresh capital to the market, according to Aon's investment banking division, Aon Benfield Securities.
Issuance of so-called "cat bonds" reached $3.6 billion in the first half of 2012 – doubling the total reached in the same period last year, Swiss Re told Reuters, while other investors say the market is set for "explosive growth".
Insurers and reinsurers have used catastrophe bonds since the 1990s to manage their exposure to natural disasters by transferring potential losses to investment funds. Investors receive a high rate of interest but risk losing all or part of their principal if a catastrophe occurs.
"The market has fought back to absolute net growth," said Martin Bisping, head of non-life risk transformation at Swiss Re – for the first time since the market stagnated after the 2008 financial crisis. New issuance is now outweighing expiring bonds, which typically have a three-year maturity, he said.
Cat bond issuance totaled just over $7 billion in 2007, and was at nearly $6 billion in 2008 before falling sharply as the financial crisis struck. But the market for cat bonds has since improved as investors' memories of the financial crisis faded, soothed by double-digit returns for many cat bonds and other products in the Insurance Linked Securities (ILS) sector.
"The market can grow to $40 billion in the next five years," John Seo, co-founder of ILS fund, Fermat Capital Management, told Reuters.
Catastrophe risk has grown faster than available reinsurance capital, as more people move to disaster hotspots, resulting in U.S.-based state entities, such as the California Earthquake Authority, looking to catastrophe bonds for coverage.
In May, publicly funded state body, Citizens Property Insurance Corporation, sold the largest ever single tranche deal in cat bond history, securing $750 million from capital market investors to protect itself from Florida hurricane risk.
Key components of heightened demand from investors include the promise of attractive yield returns from a sector that is uncorrelated with the rest of the financial market.
"Financial market turmoil or the peripheral sovereign debt crisis in Europe doesn't trigger a hurricane or earthquake, and conversely, the impact of a natural disaster on the financial makers are limited," said Bisping.
"The cat bond market is past its infancy stage," said Bisping. "It has grown from a few specialized investors to becoming an established product in the reinsurance market."
"People are going to be surprised at how quickly the cat bond market grows" said Seo.
Cat bond issuance currently stands at $4.3 billion, according to Swiss Re.
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