Market and regulatory stresses are causing catastrophe insurers to partner with capital markets to finance risks such as earthquakes and hurricanes, according to asset management firm GAM.
The shift towards capital markets means another record year for catastrophe bond issuance which is expected to reach $9bn this year, the firm said.
John Seo, GAM Star Cat Bond manager, added that: 'Catastrophe insurance markets are moving from a self-retained model toward a capital markets finance model.
'Driven by the increasing urbanisation of coastal areas worldwide and more volatile climate trends, rapidly growing catastrophe risks have created significant shortfalls in insurance coverage versus the economic value at risk.'
Disaster gaps now stand at between $300bn and $500bn globally and are particularly prevalent in the US coastal regions threatened by cyclones or earthquakes.
Seo explained that growing disaster gaps, in conjunction with increasingly stringent capital adequacy rules for insurers, such as the incoming Solvency II, were leading catastrophe insurers to partner with external sources of capital to help shoulder the burden of rapidly growing catastrophe losses.
He said this had resulted in a burgeoning market for cat bonds: 'Cat bonds and other insurance-linked securities (ILS) today cover just under 10-12% of capital needs. It is a sizeable deficit that is the primary driver of growth in the asset class.'
It means that 'cat bond issuance is expected to approach a record $9bn by the end of 2014', according to Seo.
A landmark issuance this year was a $1.5bn hurricane bond issued by Florida Citizens Property Corporation, an insurance company wholly owned by the State of Florida, the firm highlighted. This bond paid a quarterly floating rate coupon of US Treasuries of plus 7.5%.
Seo said: 'At the time of issuance, its coupon spread was more than double the spread over US Treasuries of comparably rated (single B) corporate bonds.
'The bond demonstrates the yields available for investors who diversify away from traditional fixed income investments into catastrophe bonds, which are almost entirely uncorrelated with the wider macroeconomic environment.'
