More cat on capital markets

Index-based catastrophe futures have begun trading on the New York Mercantile Exchange (NYMEX) using a loss index created and maintained by London based broker Gallagher Re. Gallagher Re bases the Re-Ex Index on loss estimates from Property Claims Services (PCS), part of the Insurance Services Office. NYMEX is the world's largest physical commodity futures exchange and an important trading forum for energy and precious metals, and the cat risk index contracts are aimed at the energy market as well as insurers and reinsurers.

There are three individual indices: nationwide, Texas to Maine excluding Florida and Florida only. The perils covered are meteorological, (hurricane, tropical storm, wind and thunderstorm, water damage and winter storm) and riot, volcanic eruption, utility service disruption and wildfire. Gallagher Re creates the index value by taking the PCS loss damage estimates for a calendar year or applicable quarter or month and dividing the value by $10 million.

There have been previous efforts to establish a market in catastrophe derivatives, mostly notably on the Chicago Board of Trade and Bermuda, that started with great enthusiasm but which quietly fizzled out for lack of risks offered. Gallagher Re believes that this time is different. According to Larry Tucker, Gallagher Re's head of specialty, both insurers and investors are comfortable with the concept and the types of contracts, while the much greater sophistication of catastrophe modelling allows them to be used by hedge funds.

When it comes to securitised catastrophe risks, total annual bond issuance has more than tripled in two years, according to a report issued by Guy Carpenter, The Catastrophe Bond Market at Year-End 2006: Ripples into Waves. Total issuance in 2006 stood at $4.7 billion, representing a 136% increase over the previous record of $2.0 billion in 2005, and a 311% increase over the $1.1 billion issued in 2004. A total of 15 sponsors completed 20 new transactions in 2006, representing a new high in transaction volume. In terms of total risk capital outstanding, the market also saw record growth, with more than $8.5 billion of bond principal outstanding at the end of 2006 - a 74% increase over the year end 2005 total of $4.9 billion.

Christopher McGhee, head of Guy Carpenter's Investment Banking Specialty Practice and Managing Director of MMC Securities, commented, "In nearly every measurable way, 2006 was, by some distance, the most active year in the history of the catastrophe bond market, principally driven by the 2004 and 2005 hurricane activity."