Pension Funds Engage in Cat Bond Spending Spree

(April 22, 2013) — Pension funds are heavily investing in catastrophe bonds to benefit from uncorrelated and high returns, resulting in sales rising by more than a fifth in the first quarter of 2013.

Figures published in a report by Clear Path Analysis on Monday showed last year’s sales volume was the highest in absolute terms since 2007, and the second biggest since records began in 1997.

As an example, pension fund investing helped increase the size of Bosphorus 1 Re Ltd. Cat bond soar to $400 million. This is an increase of 300% since the firm was launched.

This newfound popularity over cat bonds has been partly due to the attractiveness of the bonds themselves, they are not closely linked with the stock market or economic conditions.

Investors have used the commonly known “cat bonds” since the 1990’s in an attempt to manage their exposure to natural disasters by transferring losses into investment funds.

The total value of catastrophe bonds outstanding is close to $16 billion – according to data from clear path analysis report. Property and casualty insurers issued $1.64 billion worth of bonds in the first three months of the year. 

Aon Benfield, a reinsurance broker, released its insurance linked securities (ILS) index which revealed, that cat bonds returned 12.7% in the year to the end of March, returning double the investment for investors. 

Paul Schultz, chief executive officer of Aon Benfield Securities, said: “Capital flows into the ILS sector materially changed the tone of the market in the first quarter of 2013.

“Risk-adjusted pricing decreases benefited clients and visibility of the catastrophe bond market has never been higher. Momentum gained in the first quarter of 2013 has most certainly carried forward into the second quarter of 2013, both in terms of capacity and price.”

In total three cat bonds closed during the first quarter, the largest being Caelus Re 2013 which provides $270 million of capacity to sponsor for US hurricane and earthquake exposures nationwide. 

The asset class isn’t without its downsides though: in 2011, three cat bonds left their investors with high losses worth a total of $500 million after severe natural disasters and storms in Japan and in the US. 

The market is still largely dominated by repeat issuers; -in order for the bonds to continue to be successful encouragement is needed for new players to enter the ILS market, Aon Benfield’s Chris Parry, director and head of international capital markets, said in Clear Path Analysis’ report.

He also noted that while there is a large supply of capacity, and as such, pricing is very competitive, there are a number of reservations shared by investors and pension funds about entering the European reinsurance market.

Parry said: “We will overcome these challenges as people become more comfortable with the capital markets and the association with third party capital.

“It is very much an educational process to get people comfortable with the structures and costs associated with accessing the market. But it is certainly going to move forward if prices continue to come down, as we are seeing at the moment.”