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Why catastrophe bonds could be coming to Canada

Beachfront homes lie in ruin in the aftermath of Hurricane Sandy in the Rockaways, New York, Nov. 4, 2012. Munich Re, the world largest re-insurer (that is, the insurance companies’ insurer) knows the planet’s weather is changing radically and quickly because it is writing the cheques to cover the losses. Last autumn it said that natural catastrophes have doubled in the last three decades; extreme weather can take most of the blame.

Steven Greaves/Corbis

When it comes to the hunt for yield, natural disasters could be an answer for Canadian investors.

Governments and insurers in other countries reduce the risk of natural disasters such as earthquakes or hurricanes by selling catastrophe bonds through the capital markets, and a Canada-exposed investment of that kind could be coming soon, Sharon Ludlow, chief executive of global reinsurance giant Swiss Re's Canada office, said in an interview.

"There's a fair amount of industry interest in looking at [catastrophe bonds] as a complementary solution to traditional reinsurance, so I would say we're getting quite close to being able to issue Canada-only exposure," Ms. Ludlow said.

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Known as cat bonds, the high-interest investments are attractive to investors seeking yield in a low interest rate environment. A cat bond maturing in roughly three years would pay out an average of 5.56 percentage points more than short-term lending rates, according to Bloomberg. That makes them attractive compared to corporate debt. The catch is, investors could lose some or all of their initial investment if a disaster strikes. The sellers use the bond sale proceeds to cover insurance claims or damages stemming from extreme weather or other disasters.

Pension funds across North America have traditionally been buyers, Ms. Ludlow said, because of both the returns and as a way to diversify their portfolios, since these investments may not directly correlate with other market risks.

A June report of insurance-linked securities shows that Swiss Re's Global Cat Bond Index has performed similarly to Barclays Capital's U.S. Corporate High Yield Ba Index since 2002, except it is even less volatile. Both indexes have significantly outperformed the S&P 500 Total Return index, and the Cat Bond index is up a steady 5.2 per cent this year.

Swiss Re recently issued cat bonds with Mexico City as a way to pre-fund future earthquakes. "It helps the governments with planning, and lessens the impact of having to impact other social programs or have to raise taxes to fund the cost of these disasters post-event," said Ms. Ludlow.

Some companies' cat bonds are exposed to B.C. earthquake risk, but these bonds include other risk exposure in the U.S. as well.

While global issuance of new cat bonds peaked in 2007 at $8.2-billion (U.S.) by Swiss Re's calculations, the marketplace is currently on track for its best year since. In the first almost six months of the year, $3.5-billion in new issuance have hit the market, and there are several additional bonds in the pipeline.

(Jacqueline Nelson is a Globe and Mail Financial Services Reporter.)

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About the Author
Financial Services Reporter

Jacqueline Nelson is a financial services reporter at the Report on Business. Prior to that she was a staff writer at Canadian Business magazine, covering news and writing features on a wide variety of subjects. More


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