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Catastrophe bonds expected to surge

The catastrophe bond market is poised for an active fourth quarter as several factors combine to boost the insurance-linked securities sector, experts and observers say.

Insurers may issue $1.2 billion to $2.2 billion in new catastrophe bond capacity during the fourth quarter, an uptick that could result in a total of $3 billion to $4 billion for 2009, New York-based reinsurance intermediary, Guy Carpenter & Company and investment banking arm, GC Securities Ltd. said in a report last week.

Renewed interest by insurance companies in issuing the bonds is being driven in part, by a significant drop in cat bond pricing and investors’ greater willingness to accept lower returns on the bonds, Guy Carpenter said.

Some observers say fourth-quarter volume could be even higher than that. “We are really expecting this market to explode,” said John Seo, managing principal at Fermat Capital Management L.L.C. in Westport, Conn. “The capacity is there and there is a willingness (by insurers) to issue.” Mr. Seo said year-to-date totals could reach $4.3 billion.

In contrast, there was zero cat bond activity in the fourth quarter of 2008 as the market reeled from the collapse of Lehman Bros. and the subsequent ratings downgrade of four cat bonds backed by the investment bank. Cat bonds issued in the next few months are expected to be dominated by insurance companies buying protection for U.S. wind and earthquake exposures, although observers say some transactions will feature capacity for European windstorms and Japanese earthquakes.

Market sources said two deals are being marketed to investors: one exclusively for California quake protection, and the other for U.S. wind and quake exposures. The deals could be introduced by the end of October, sources said.

Cat bond pricing was high early this year, keeping many potential issuers on the sidelines, but has softened since then. “Insurers that were not inclined to issue during the first two quarters of 2009 because of pricing concerns” are likely to return to the market, Chi Hum, global head of distribution at GC Securities Ltd. in New York, said in a statement.

Cat bond spreads, which determine the price for issuers, have “tightened dramatically,” resulting in lower prices but some investors said they do not expect prices to drop much more in the fourth quarter.

Recovery in the broader financial markets, increasing investor capacity, also is fueling the sector.“There is currently more investors and more capital to put to work than we have had in a long time,” said Paul Schultz, president of Chicago-based Aon Capital Markets. The group of catastrophe bond investors is expanding beyond hedge funds and dedicated insurance-linked securities to pension funds and other institutional investors that have been “given the green light” to allocate a certain amount of money to the asset class, Mr. Seo said.

In addition, some $660 million in existing bonds are set to mature in the fourth quarter, with an additional $518 million in January 2010. Guy Carpenter said this is expected to further fuel the sector.

A relatively quiet 2009 Atlantic hurricane season also has made cat bonds attractive, observers say.
The sector had 11 transactions so far this year, bringing year-to-date issuance to $1.79 billion, Guy Carpenter said. The latest deal, a $290 million dollar cat bond placed by the government of Mexico and backed by Swiss Reinsurance Company, is one of three cat bonds that increased their size due to strong investor demand. MultiCat Mexico 2009 Ltd. covers Mexico’s natural catastrophe fund and is expected to close this month.


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