US storms cause “unprecedented” market activity, Guy Carpenter

Guy Carpenter & Company, Inc., a global risk and reinsurance specialist and a part of the Marsh & McLennan Companies (NYSE: MMC), and affiliate of Guy Carpenter MMC Securities Corp., recently published their fourth annual joint study of natural catastrophe bond transaction activity, trends and market dynamics, which cites unprecedented growth across the catastrophe bond market in 2005, largely driven by U.S. hurricane activity.
The report “The Catastrophe Bond Market at Year-End 2005: Ripple Effects from Record Storms,” states that the catastrophe bond market recorded total issuance of US$1.99 billion in 2005, a 74% increase over the US$1.14 billion issuance in 2004 and 15% higher than the previous record of US$1.73 billion issued in 2003.
In addition, total risk capital outstanding had increased to US$4.9 billion by the end of 2005 – a 21% increase over the US$4.04 billion outstanding at year-end 2004 and a 42% increase over the US$3.45 billion at year-end 2003.
“The story of the catastrophe bond market in 2005 was the story of U.S. hurricane activity, principally Hurricane Katrina,” Christopher McGhee, head of Guy Carpenter’s Investment Banking Specialty Practice and managing director of MMC Securities, says. “Prior to 2005, cat bond investor demand far outstripped supply, but the 2005 storms have reversed this trend. Not only did we witness record highs in terms of total risk capital issued, total risk capital outstanding, number of bonds placed and number of first-time sponsors, but the market also suffered its first significant loss to a publicly disclosed catastrophe bond.”
McGhee adds that there have been numerous important market developments as a result of Katrina and, although to a lesser extent, Hurricanes Rita and Wilma. Rating agencies, he says, are revising their capital requirements upward for insurers and reinsurers with catastrophe exposures. In addition, McGhee notes that modeling firms have also announced plans to revise their models, which has led to “substantial uncertainty concerning 2006 renewal pricing, as well as a dramatic rise in the cost of reinsurance for companies that had suffered catastrophe losses in 2005.”
The reports highlights include:
* Increase in Number of Transactions – The ten transactions completed in 2005 represent the largest number of deals issued in a single year, tying the record set in 1999. Since 1997, the first year that multiple transactions occurred, 69 catastrophe bonds have been issued, with total risk limits of US$10.65 billion.
* First Significant Loss to a Publicly Disclosed Bond – Hurricane Katrina’s devastation is expected to have caused a total loss to the KAMP Re 2005 Ltd. issuance, a US$190 million dollar transaction. This would represent the first total loss to a publicly disclosed catastrophe bond.
* Capacity Tightening Post-Katrina – While the investor base for catastrophe bonds continued to show strong demand, there was some capacity tightening towards the end of 2005, as multi-strategy hedge funds elected to access insurance risk through “sidecar” and other start-up reinsurance companies brought to market post-hurricanes, rather than through catastrophe bonds. The volume of cat bonds issued during a short timeframe at the end of the year also stretched the resources of investors.
* Increased Inquiry Flow Post-Katrina – A series of factors, including a tight catastrophe reinsurance market stemming from the storm losses of 2005, as well as the resultant announcements by the major insurance rating agencies and risk modeling firms that they would be overhauling their respective methodologies in 2006, contributed to a substantial increase in inquiries by insurance and reinsurance companies looking to explore cat bonds as a supplement to their traditional reinsurance programs.