When these risky securities appeared, only specialist hedge funds or other asset managers with expert knowledge of disaster risk dared buy them, meaning the market was small compared with the reinsurance world at large. In the past couple of years it has swelled dramatically, however, with a record $4.75bn cat bonds issued in the first four months of 2014 alone. And mainstream investors have jumped in: last year about four-fifths of the bonds were bought by pension funds and other large institutional managers.
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In part, cat bonds appeal because they offer better returns than the current ultra-low yields on risky corporate bonds. But they have another attractive feature: they are seen as "uncorrelated" with other asset classes. This is highly prized since the 2008 financial crisis, when many markets fell in tandem, making it hard to hedge risks.
But as investors have rushed in, the inevitable has occurred: yields have plunged. The average yield in recent months on a basket of cat bonds has hovered just over 5 per cent, about half the level seen two years ago. In some ways this is good news: falling yields helped cut the cost of buying insurance for consumers by about 15 per cent last year. The fact that the insurance sector is gathering a diversified pool of capital could make it more resilient. So much so that Jay Gelb of Barclays Capital says "alternative capital", such as pension funds, could in the coming years represent "up to 30 per cent" of the $300bn US property catastrophe reinsurance market, up from 15 per cent today.
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