The recent downgrades of


numerous cat bonds triggered by changes to the risk models underpinning them may be a contributory factor in a


sharp reduction in the number of non-specialised investors contributing to this sector. Pete Vloedman of Anchor Risk Advisors analyses this dynamic.


R


ecent newswire headlines have brought the rationale for obtaining credit ratings on catastrophe (cat) bonds back into the structuring discussion. According to Swiss Re, approximately 94


percent of cat bonds in circulation have a credit rating. But what purpose do they serve? Are they worth the cost? Are credit ratings necessary to achieve full distribution of a cat bond? This article discusses the historical and current rationale for cat bond credit ratings.


WHY DO CAT BONDS HAVE


CREDIT RATINGS? In 1973, Richard Sandor (‘the father of financial futures’) and Robert Goshay proposed the idea of reinsurance futures contracts to hedge catastrophe risk. After some discussion, this concept quietly faded away. In 1989, Hurricane Hugo, at the time the largest-ever insured natural catastrophe loss (approximately $4 billion), provided the impetus for the idea to be revisited and, by 1991, work had begun on the first-generation Chicago Board of Trade catastrophe futures contracts.


Various industry stakeholders such as insurers, investment banks,


reinsurers and reinsurance brokers tried to create a security to transfer commoditised catastrophe risk out of the insurance sector and into the broader capital markets. Although two versions of futures contracts were tried, neither enjoyed long-term success. However, the concept of securitising standardised natural catastrophe risk and distributing it to non-insurance investors caught on and eventually took various forms, including cat bonds.


November 2011 | INTELLIGENT INSURER | 37


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