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Catastrophe bonds drive down disaster reinsurance rates

* Rise in companies using cat bonds instead of reinsurance

* Using capital market investors to keep expensivereinsurance costs down

* High investor demands keeps costs down for sponsors * Issuance may hit $7 bln this year By Sarah Mortimer

LONDON, Oct 9 (Reuters) - The market for catastrophe bondshas boomed in the past year and is likely to keep growing asinvestors search for higher returns.

The volume of outstanding bonds is set to reach $15 billionthis year, a near 30 percent increase from 2011, say investors.Sales of new bonds doubled in the first six months of 2012,falling just short of 2007's record for first-half issuance,according to Swiss Re .

Known widely as cat bonds, these securities are typicallyissued by big reinsurers to cover a low-probability, high-lossevent, such as a destructive hurricane, thereby freeing upcapital and allowing them to underwrite more basic business.

The latest trend is for big primary insurers and U.S.publicly funded disaster agencies to issue them as well.

Investors receive a high rate of interest by buying thebonds but risk losing part or all of their money if acatastrophe occurs. The attraction is that the risk of a catbond triggering is small.

Such bonds have become more popular since reinsurers - whichinsure insurance companies - last year suffered theirsecond-worst annual losses from natural disasters ever,including a $116 billion hit from the Japanese earthquake.

That disaster was so severe it triggered a cat bond issuedby Munich Re that forced investors to pay $300 million to thereinsurer.

Regulators are also adding to demand by forcing reinsurersto set aside more capital to cover disaster risk under theSolvency II directive.

Demand from capital markets investors has helped keepoverall catastrophe insurance costs from rising.

"By adding a cat bond to your portfolio of reinsuranceprotection, a sponsor (issuer) can keep costs in line over timeand place subtle pressure on traditional reinsurance pricing,keeping it more competitive," says Michael Halsband, director atDeutsche Bank Securities Inc

The lure for investors is the high return offered by suchbonds, which are rated below investment grade - an average 7.4percent this year, although yields have come down with risingdemand.

The chances of the bonds being triggered, meanwhile, arerelatively remote because they cover very specific risks inspecific geographic areas.

For example, only one of the nine cat bonds covering theGulf region was triggered by Hurricane Katrina, the insuranceindustry's most costly natural disaster.

NEW SPONSORS

The market has attracted two to five new issuers in each ofthe last 10 years, including in recent years large primaryinsurers and U.S. state government entities with massiveexposure to natural disasters. These include the LouisianaCitizens Property Insurance Company, Florida's Citizens PropertyInsurance Company and the California Earthquake Authority.

Last year's heavy disaster losses and the Solvency IIdirective have forced reinsurers to either pull out of providingsome catastrophe insurance or charge more to cover the risk.

"Capital markets capital provides a diversification ofsources and extra competition, which means we can find the rightlevel of pricing," said Tim Richardson, chief financial officerat the California Earthquake Authority (CEA), which purchases upto $3.5 billion of reinsurance cover each year to pay potentialclaims against earthquake damage from California homeowners.

The CEA started sponsoring catastrophe bonds last year undera reinsurance deal with Bermudan entity Embarcadero Re, and hassold a total $600 million of cat bond notes to date.

Being able to access the capital markets "helps to keepeveryone honest about pricing," said Richardson.

FURTHER GROWTH

"The insurance-linked securities market is no longer seen ashot money," says Rick Miller, senior vice president at TowersWatson Capital Markets, whose parent helped to sell an $11.95million bond for an undisclosed middle-tier Florida-basedinsurance company - underlining the interest from smallercompanies.

Catastrophe bond issuance is likely to grow by 25 percent in2012, reaching up to $7 billion by the end of the year,according to brokers and investors.

Chi Hum, managing director at GC Securities, part ofbrokerage Guy Carpenter , reckons the market forinsurance-linked securities - of which cat bonds are the majorpart - could grow from $30 billion to $45 billion by 2015.

"In the current economic environment, there is more thanadequate capital from investors to meet the sponsor's presentneeds .... which ought to attract yet more new sponsors," addsDeutsche's Halsband.

- For more details on cat bond transactions, see the ThomsonReuters Insurance Linked Securities Community .

(Editing by Jeremy Gaunt)

((sarah.mortimer@thomsonreuters.com)(+44)(0)(20 75429619)(Reuters Messaging:sarah.mortimer.thomsonreuters.com@reuters.net))

Keywords: INSURANCE BONDS/INVESTMENT