Cat bond market could more than double to US$50 billion by 2018: BNY Mellon

Insurers and capital markets need to harness big data to close the disaster gap – the difference between insured and economic costs of natural catastrophes – suggests a new report from BNY Mellon that indicates the cat bond market could balloon to US$50 billion by 2018.

The number of cat bonds outstanding could more than double from the current level of US$19 billion (as reported by Aon Benfield) to US$50 billion by the end of 2018, notes a statement issued Thursday by BNY Mellon, which provides investment management and investment services.

Cat bonds are risk-linked securities that transfer a specified set of risks associated with hurricanes or earthquakes from an insurer or a nation state to investors.

BNY Mellon estimates the total amount of insurance-linked securities (ILS) outstanding could reach US$150 billion by the end of 2018, US$50 billion of which is expected to include publicly traded cat bonds, the statement adds.

Globally, natural catastrophes cost the insurance industry approximately US$13 billion in the first half of 2013, with the overall economic losses estimated at about US$45 billion, notes BNY Mellon, citing figures released by Munich Re in July. The industry, therefore, covered less than one third of natural catastrophes, leaving a global disaster gap of US$32 billion, BNY Mellon adds.

BNY Mellon research based on market data from Artemis indicates that cat bonds are growing at their fastest pace in six years. “The initial investor base was dominated by hedge funds and private equity, but we are seeing more long-term investors, such as pension funds buying cat bonds,” Dean Fletcher, head of EMEA Corporate Trust at BNY Mellon, says in the statement.

“Investors are attracted by the high yields in the current low interest rate environment. Cat bonds also offer investors a chance to diversify their portfolios because of the low correlation of risk between catastrophic events and broader financial markets,” Fletcher continues.

“Insurers and the capital markets can help reduce the disaster gap by working together with big data to deploy new capital to cover new perils in new regions. This will reduce the cost of rebuilding for governments and provide a positive contribution to society,” Paul Traynor, international head of insurance for BNY Mellon, says of the study, The disaster gap: How insurers and the capital markets can harness big data to close the gap.

The study notes that a combination of legacy and predictive big data models will produce more robust risk modelling for cat bonds. These models should include unstructured data, fast-changing data and data generated from an increasing number of sensors, mobile devices and social media applications, it adds.

“Never has the experience of the insurer been needed more; deploying capital against previously uncovered risks requires deep underwriting and technical expertise,” Traynor suggests. “This expertise, as well as the comfort that comes from seeing insurers using their own capital, will encourage the capital markets to invest in more cat bonds.”

The report predicts a compound annual growth rate (CAGR) of 25% for ILS as an asset class and 20% for cat bonds as a subset of this.