Market Flourishes for Investing in Disaster Risk

BNY Mellon predicts catastrophe bond sector will reach $50 billion by 2018

House destroyed in Hurricane Sandy (Photo: AP) House destroyed in Hurricane Sandy (Photo: AP)

Catastrophe bonds are growing at their fastest pace in six years, and outstanding issues could reach $50 billion by 2018, up from their current $19 billion, according to BNY Mellon.

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.

In a new report, BNY Mellon estimated that the total amount of insurance-linked securities, of which cat bonds are a subset, could reach $150 billion by the end of 2018.

Insurance-linked securities as an asset class will experience a compound annual growth rate of 25%, the report said. Cat bonds as a subset will grow by 20%, compared with 30% growth over the past nine years.

In a statement, BNY Mellon acknowledged that it acted as a trustee and paying agent, and collateral agent on cat bonds. Last year, it was trustee on 68% of all cat bonds.

Hedge funds and private equity initially dominated the cat bond investor base, according to the report. Now, more long-term investors such as pension funds are buying the products.

“Investors are attracted by the high yields in the current low-interest rate environment,” Dean Fletcher, head of EMEA Corporate Trust at BNY Mellon, said in the statement.

“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.”

Natural catastrophes across the globe cost the insurance industry approximately $13 billion in the first half of this year, with overall economic losses estimated at some $45 billion.

As a result, the industry covered less than one third of natural catastrophes, leaving governments and society on the hook for $32 billion of rebuilding costs. Climate change and urbanization will likely exacerbate future losses from catastrophes.

“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,” BNY Mellon’s international head of insurance Paul Traynor said in the statement. “This will reduce the cost of rebuilding for governments and provide a positive contribution to society.”

The report suggested that a combination of legacy and predictive big data models will produce more robust risk modeling for cat bonds. It said these models should include unstructured data, fast changing data and data generated from an increasing number of sensors, mobile devices and social media applications.

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