Expert Risk Articles

Cat Bonds

Richard Boyd, responsible for Business Development and Underwriting at Allianz Risk Transfer, explains the concept of Cat Bonds and how Allianz is involved with them.

What is Allianz Risk Transfer and how are you involved in the Cat Bond market?

Allianz Risk Transfer (ART) provides tailored insurance, reinsurance and other non-traditional risk management solutions for corporate and financial clients worldwide.

We have been active in the Cat Bond market for over 10 years and have invested in bonds opportunistically as market conditions have allowed. We issued our own bond "Blue Coast", which recently expired but almost triggered a loss payment following hurricanes Gustav and Ike in 2008.

By being active on both sides of the market we can also provide market insight to the Allianz group and help it in its decision-making regarding the issuance of cat bonds. ART has also aided Allianz in accessing the investor markets through private collateralized transactions and works closely with Allianz Re to discuss alternative ways to access reinsurance risk. We continue to be excited about this market and welcome its development as an alternative and enhancement to the traditional insurance market. In the future, we expect the market to grow modestly and continue to innovate. ART aims to be at the forefront of this development

Can you say a few words about the supply of Cat Bonds in the markets today?

Cat Bonds are now an intrinsic part of the reinsurance purchase of most large insurance companies, including Allianz, and also some reinsurance companies. Certain companies issue a bond once a year or even more, and Allianz is a regular participant too. As a reinsurance product, there is very clear certainty of recovery offered by a collateralized solution such as a cat bond, and - being multi-year - they offer pricing stability across the reinsurance pricing cycle. Cat bonds also diversify counterparty exposure and credit risk for purchasers which in the Solvency II world could be a significant capital issue.

Certain perils such as US hurricanes and earthquakes dominate the issuance calendar but mortality and longevity-related bonds along with healthcare, credit and motor insurance bonds also add a level of diversification which is welcomed by the investor community. Cat bonds add to the toolbox of multi-line insurance groups like Allianz seeking to protect their balance sheets.

The trend in 2011 is towards more private style transactions which can be done in smaller size and with reduced frictional costs. An example of this is the CWIL product (county weighted industry loss), developed by Guy Carpenter and Nephila Capital, and which recently won the derivative initiative of the year at the Trading Risk Awards in London. This is a variation to the more well-known ILW (insurance loss warranty) contract, but providing lower basis risk for buyers as they can buy reinsurance protection at the more granular county level. We have supported the growth of this product and have helped Allianz to be one of the first to use the product as a tool for protecting the group balance sheet.

And how strong of a demand are you currently experiencing and what are the market trends?

The investor community is maturing and starting to be dominated by dedicated catastrophe funds whose investors are increasingly coming from the pension fund community rather than the hedge fund community, which dominated the early days of the market. This brings with it a different risk tolerance profile. Hence, the less risky and therefore lower priced bonds are becoming highly sought after, as these exposures tend to be diversifying perils. Pension funds investors are unlikely to be excited to see a single hurricane or earthquake wipe out a large proportion of their investment so they will be seeking more diversity and lower returns which should drive a different demand profile than previously seen.

Of course, the advantage that these types of investors have is that their cost of capital is lower than that of a traditional reinsurer and as such they can compete on price with the traditional reinsurance market. Since this product does not really correlate with other financial risks, it makes sense for large investors to add this risk to their portfolio. As such, the demand should increase for access to the cat market, be it through cat bonds or other tailored private transactions.

How about the secondary market -- what is happening there?

There is now a fairly healthy secondary market where bonds can be bought and sold by investors. A number of broker-dealers offer to bring buyers and sellers together allowing investors to balance their portfolios. Liquidity in the secondary market is still fairly low, however. Other alternatives to trying to sell bonds in the secondary market include buying and selling coverage on the same underlying cat index, a practice which is becoming much more common and - we feel - provides some interesting opportunities to manage the market cycle and take advantage of pricing differentials in the different sectors of the reinsurance market.