How does a cat bond work?
Amer Ahmed: Cat bonds enable capital markets to help insurers cover their peak natural catastrophe risks. Insurers like Allianz have regional peak catastrophe exposures such as hurricanes or earthquakes in Europe and the US and traditionally pass on some of these risks to the reinsurance market. Alternatively, the risk can be passed on to investors via a cat bond. Like any bond, a cat bond has a maturity and a coupon which reflects the risk. If a pre-defined trigger event occurs before the end of the defined risk period, some or all the capital invested in the bond can be used to cover claims payments made by the insurer to its policyholders. If the bond expires without any trigger event, investors will be paid back their principal.
Why turn to cat bonds?
Allianz uses cat bonds as an alternative and supplement to traditional catastrophe reinsurance. Allianz Re is responsible for managing the Group’s natural catastrophe exposures within a defined risk appetite. We do this by a using a variety of instruments and providers, in particular at times when capital in the reinsurance sector is constrained. Here cat bonds are attractive because they allow Allianz to diversify protection sources by accessing the capital markets as additional risk-takers. Cat bonds typically provide cover on a multi-year basis and are collateralized, thus they provide some stability and mitigate counterparty credit risk exposure.
What does this particular cat bond cover?
The new transaction protects Allianz against the risk of losses from storm events in the US, Mexico and the Caribbean as well as earthquake events in the US and Canada. The bond allows us to lock in a competitive price over a period of three years for protection against natural catastrophes. Thus, we can benefit from the currently very attractive conditions which result from the strong demand for cat bonds in the capital markets. Given those conditions we decided to upsize the cat bond from the originally planned volume of 150 million US-dollars to 175 million US-dollars.
Who benefits from this cat bond?
The cat bond transfers a portion of the risk that Allianz accumulates as an insurance group to the capital markets. In this respect, Allianz and ultimately its customers benefit from the collateralized cover provided by the cat bond.
Are you intending to work more with cat bonds?
Allianz has been active in the cat bond market since 2007 and intends to sponsor cat bonds from time to time to complement our traditional reinsurance covers, especially for so-called peak risks. We regularly review our coverage needs and risk protection options as well as our expectations regarding pricing. Hence, cat bonds are a key part of our risk management approach.
How is the cat bond market developing?
The market has developed substantially since its origination in the mid-1990s, and gained significant momentum from 2003 through 2007. After a decline in 2008, new annual issuance has grown again and reached a level close to 6.3 billion US-dollars in 2012. Cat bonds have become an integral component in the protection strategy of many insurance and reinsurers, even though the majority of transactions remains focused on peak risks, such as US hurricane and earthquake. For investors in this asset class, cat bonds have become increasingly popular over the past years because of their low correlation with most other asset classes while offering relatively attractive returns.