Cat Bonds Still Rare in Lightly Insured Emerging Markets

In late April, the Turkish Catastrophe Insurance Pool (TCIP) issued a $400 million cat bond, its first ever.

The deal surfaced at a time when the sector is experiencing rapid growth and drawing in new investors, with global cat bond issuance potentially coming within reach of 2007’s $7 billion record, observers say.
Conditions it would seem are ripe for other emerging markets to follow Turkey’s suit, and hedge the sorts of risk that are present everywhere.

But cat bond players said that insurance penetration would have to rise to much higher levels for emerging-market cat bonds to widen their share of the overall market, which has remained slight for years.

Still, it is likely to grow over the long-term as insurance levels edge towards the rates seen in the West, encouraged by both governments and multilateral banks such as the World Bank and the Asian Development Bank.

Young Turks

The Turkish transaction is not the first from emerging markets — there have been deals out of Taiwan and Mexico, while Turkish risk has been folded into another transaction. All the same, cat bonds outside the U.S. and Europe are remarkably rare.

“Generally speaking the cat bond market is heavily skewed towards U.S. peril,” said Paul Schultz, CEO of Aon Benfield Securities.

It is not as if transactions from emerging markets represent far more work for arrangers because they are radically different from what investors understand cat bonds to be.

TCIP, for instance, is analogous to the U.S. insurance pools that have issued cat bonds. State sponsored hurricane residual pools have been floating deals over the past few years, the first being Parkton Re in 2009, according to a Swiss Re report. Since then, pools in Massachusetts, Louisiana and Florida have tapped the capital markets for reinsurance. 

Arranged by GC Securities, the cat bond benefitting TCIP provides three years of protection from earthquakes affecting the Istanbul region. The deal triggers are based on measurements captured at specific ground motion seismometers, some of which were placed specifically for the transaction.
“It’s a bespoke trigger structure,” said Cory Anger, global head of ILS (insurance-linked securities) structuring at GC.

In a sign that cat bond investors are open to this corner of the market, a range of buysiders snapped up the Turkish deal, which was rated ‘BB+’ by Standard & Poor’s. They included hedge funds, asset managers, endowments, mutual funds, family offices, and pension funds focused on ILS, according to Anger. The ILS-dedicated funds bought up 62% of the deal’s volume. The second largest group of investors was hedge funds, with 16%. In all, there were 26 investors in the deal, priced at a spread of 250 basis points over U.S. Treasury money market fund earnings.

Unlike other kinds of structured finance deals out of emerging markets, cat bonds from this part of the world are not perceived to carry currency risk for the investor.

“The cash flows are usually all in U.S. dollars,” said Maren Josefs, associate director of financial services at S&P. “It’s not something that we look at when we rate these deals.”

Indeed, the risk modeling is very similar to the approach for developed country cat bonds, Josefs added. But, as with any model, there can be elements that are untested. 

In the Turkish deal, for instance, it was the first time the agency rated a transaction using Risk Management Solution’s model for predicting the frequency and severity of earthquakes in Turkey.

“We are not as familiar with this as we are with the U.S. models,” Josefs said. “[So] we spent more time with the risk analysis and adjusted our stresses accordingly to take this extra uncertainty into account.”

Multilateral Muscle

While this market remains undeveloped in emerging markets, multilateral development banks are keen to see it grow.

“Innovative forms of risk transfer, like catastrophe bonds, can play an important role in increasing resilience and helping recovery from major natural catastrophes,” said Arup Chatterjee, senior financial sector specialist with the Asian Development Bank’s office of regional economic integration.

Chatterjee said the ADB is exploring the possibility of using a guarantee from the bank to backstop catastrophe bonds issued within Asia, while it is looking into ways to advance catastrophe risk financing in the region.

But so far it has not been involved in cat bonds.