A spate of new cat bonds suggests insurers increasingly prefer the capital markets for risk management

Earlier this month as it completed its second motor securitisation, AXA claimed insurance-linked securities had become an effective alternative to reinsurance.

“We are confident that the market for ILS will continue to develop, as they are an efficient risk and capital management tool for the insurance industry, as well as a new attractive asset class for investors,” said Denis Duverne, AXA’s chief financial officer.

Other primary insurers are waking up to alternatives to traditional reinsurance, particularly for catastrophe cover.

Despite a benign hurricane season in 2006 and the return of capacity to the market, property catastrophe reinsurance remains expensive. Reinsurers continue to perceive the risk to be hgher, partly due to new catastrophe model predictions.

Catastrophe bonds have thus become a popular means of gaining cover for certain classes of peril.

In May, Allianz Global Corporate & Specialty announced it had closed a catastrophe bond for $150m. It uniquely hedged the risk of flooding in the UK against earthquakes in Canada and the US. Swiss Re fronted the transaction and also acted as arranger and lead manager.

Swiss Re, which often concedes its biggest customers are also its biggest competitors, has been quick to get involved in the new trend. Its most recent venture, a catastrophe bond covering Japanese typhoons, using another cat bond – CAT-Mex (which covers earthquakes in Mexico) as a trigger, was partly sponsored by Kyoei Fire & Marine Insurance.

“We are confident that the market for ILS will continue to develop, as they are an efficient risk and capital management tool for the insurance industry

Denis Duverne

Other insurers testing the waters include US property casualty insurers Allstate, Travelers and State Farm.

In May, Travelers announced it had established Longpoint Re. This is a $500m multi-year catastrophe bond programme to provide reinsurance protection for Travelers insurance subsidiaries for losses resulting from hurricanes and certain other catastrophes in the US.

State Farm followed suit in June announcing it was to place $4bn in catastrophe bonds through its independently owned reinsurance vehicle Merna Re. The size of the cat bond, was in itself unique, according to Fitch.

The transaction transfers a portion of State Farm’s risk of natural catastrophe losses in the US and Canada including hurricane, earthquake, tornado, hail, winter storm and brush fire to the capital markets.

Also in June, Allstate issued its first hurricane-linked cat bond under the $2bn Willow Re programme. This should prove a welcome solution for the insurer, which since Katrina has been forced to defend rate rises in California and other catastrophe-prone states, as well as its decision not to renew certain policies.

Many US P/C insurers reassessed their exposures after Hurricanes Katrina, Rita and Wilma in 2005. With the risk perceived to be greater, reinsurance expensive and capacity unavailable, the options were limited and they were forced to retain more risk. This meant they had to reduce their exposure in catastrophe-exposed regions.

With the growing option to transfer catastrophe risk to the capital markets, this should help to reduce the exposure for primary insurers, which cannot obtain adequate reinsurance protection. Traditional reinsurance could even – as AXA predicts – become a supplement to this new method of transferring risk.