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Catastrophe bonds try to break new ground in pensions despite rift of opinion

17 April 2012

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Pension funds can reap rewards from record issuance of catastrophe bonds, claims a new Clear Path Analysis study.

 

The research group states that a record $2bn of the bonds, which are a form of reinsurance against natural disasters, were issued in the first quarter of 2012.

 

Pension funds are being urged to step in with their investment at a time when insurers against natural disaster are scrambling to cope with the aftermath of an eventful 2011. Last year saw earthquakes in Japan and New Zealand along with severe flooding in Thailand, while a hurricane hit the North East coast of the United States.

 

Reinsurance company Munich RE estimates that $110bn was lost by insurers in 2011 due to natural disasters.

 

Michael Stahel, head of insurance-linked investments at asset manager Clariden Leu says: "That money will be paid out, leaving insurance and reinsurance companies with a limited capital base. These companies are now trying to recapitalise themselves and are approaching the reinsurance linked market to recapitalise."

 

Stahel adds that he expects premium levels for catastrophe bonds to increase steeply.

 

Pension funds that hold catastrophe bonds directly or via funds include the BBC pension fund, the Ontario Teachers' Pension Plan and the Swedish scheme AP3.

 

Greg Hagood, head of reinsurance at specialist investment managers Nephila Capital said in the study that catastrophe bonds are a useful way for pension funds to diversify and find an alternative to traditional bond holdings.

 

Hagood says though that some pension funds approach the bonds "from an absolute return, hedge fund type of mind-set, recognising that the reinsurance market is opaque, there is no pricing available in Bloomberg and it is a market where one would think that there is some Alpha to be extracted. Generally these people are looking for higher returns and actively managed portfolios where some source of alpha extraction would be expected."

 

Hagood concedes that allocations from pension fund to catastrophe bonds rarely extend beyond 1-2% of the whole fund.

 

Fractured thinking?

 

Market experts point out that while catastrophe bond funds are an asset diversifier, they are often concentrated around the US natural disaster insurance market. With the internationalised nature of insurance that seems to be a quirk of the way the market has developed rather than a pattern set in stone.

 

The opaqueness of catastrophe bond investing has put off Elizabeth Garner, a trustee of the Atkins Pension Plan. Garner told Clear Path Analysis that unless it was possible to view the level of spread on the bonds, she would continue to see them as "an investment where we could potentially lose our whole investment".

 

Garner points out that while enhanced demand for disaster insurance offers possibilities, catastrophe bonds are vulnerable to uncontrollable seismic and weather patterns. Garner contends that "this is actually gambling on reinsurance and there is an awareness that the Lloyds security for Lloyds syndicates had heavy hits [in 2011] which doesn't really encourage you to look too hard at this asset class."

 

Remarkably, four of the world's six costliest earthquakes in history occurred in the last four years, and the school of thought that global warming is making weather patterns more extreme might frighten some away from the asset class.

 

Garner also says she is concerned at the possible governance issues raised if pension funds are seen to be profiting from major disasters via the interest in insurance in the event's aftermath. The counterargument to that though is that insurance is needed in regions that are at the mercy of nature and aids rebuilding efforts when disaster strikes.

 

dbillingham@wilmington.co.uk