Cat bonds go against the grain of the credit crisis

Catastrophe bonds (cat bonds) have been one of the few asset classes to prove resilient to the capital markets' turbulence over the past year.

Findings from rating agency Standard & Poor’s August 27 report on cat bonds showed drivers behind cat bonds’ pricing have either limited or no correlation to those of traditional financial instruments. This means they have been mostly detached from the volatility experienced in the credit markets over the past 12 months. The investigation demonstrated they appear more correlated to the actual natural catastrophes and underlying reinsurance pricing.

“One of the key attractions of many insurance-linked securities deals is the limited/lack of correlation to traditional investments, owing to the performance or trigger being driven by more remote and non-financial risks, such as natural perils or demographic trends,” wrote David Harrison, a credit analyst at Standard & Poor’s in London, in the report.

This has meant cat bonds have outperformed credit instruments, which lost much of their value when markets became illiquid in August last year. This can be seen in a comparison of movements in index levels for reinsurer Swiss Re’s cat bond index (bonds rated BB by Standard & Poor’s) and one of data provider Markit’s indexes of low investment-grade and speculative-grade credit derivatives. For example, since the start of the year to August 29, the Swiss Re BB-rated cat bond total return index has increased 5.23%. This compares with a reduction of 0.99% for the Markit iTraxx Crossover five-year total return index over the same period. And Standard & Poor’s expects this to continue.

“Looking forward, we expect the fundamentals driving risk pricing in insurance-linked securities in general and cat bonds in particular will continue to protect this asset class from the worst of the disruptions being felt elsewhere in the traditional credit markets,” wrote Harrison.

See also: Cat bonds find their calling
For whom cat risk tolls
At a turning point