Canada’s banking regulator is urging insurers to sell catastrophe bonds for the first time to cut the risk of natural disasters such as the record floods that inundated swathes of downtown Calgary in June.
Climate changes are making weather-related losses a “new reality for insurance companies” Julie Dickson, Canada’s top financial industry regulator, told insurers at a conference in Gatineau, Quebec, and said they would do well to preserve capital by issuing the bonds because “catastrophic risk seems to be growing.”
Catastrophe bonds, pioneered by Goldman Sachs Group Inc. and Swiss Re AG in the 1990s to deal with the aftermath of U.S. hurricanes, have helped insurers shield themselves from losses stemming from Japanese earthquakes to crop losses in Mozambique. About $18 billion of dollar-denominated cat bonds have been issued since 2007, according to data compiled by Bloomberg, including $5.9 billion so far this year.
“I have not seen a deal in the catastrophe-bond market that is focused on purely Canadian risk,” Shiv Kumar, managing director in structured finance at Goldman Sachs, said by phone from New York. “The market is very ready for it.”
Over-concentration of East Coast hurricanes and California earthquakes in the market means investors are looking for other places to invest, Kumar said, thereby reducing the chance the same disaster triggers a payout across their holdings. Canada is afflicted by earthquakes, ice and hail, and tornadoes, in addition to flooding.
‘Variety of Risks’
“There are a variety of risks that could be packaged by themselves or together with other perils and placed in the catastrophe bond market,” Kumar said.
In catastrophe bonds, insurers pay investors the premiums they collect for protection against damage from natural disasters. Investors assume the risk of a disaster striking during the life of their bonds because their principle is used to cover damage caused by a storm.
Cat bonds have returned 11.2 percent in the past year, according to the Swiss Re Cat Bond Price Return Index, compared with 6.8 percent for an index of Canadian high-yield bonds. The measure tracks dollar debt sold by insurers and reinsurers. The bonds pay average yields of 553 basis points more than short- term lending rates, compared with relative yields of 589 basis points for speculative-grade Canadian bonds, according to Bank of America Merrill Lynch index data.
TMX Bond
Elsewhere in credit markets, TMX Group Ltd., owner of the Toronto Stock Exchange, started selling C$800 million ($778 million) of securities due in three, five and 10 years. Proceeds will help refinance debt used by Maple Group Acquisition Corp. to take over the exchange last year, according to DBRS Ltd., which assigned a rating of A (high) to the new notes.
The extra yield investors demand to own the debt of investment-grade corporations rather than government held steady at 126 basis points yesterday compared with the end of last week, according to the Bank of America Merrill Lynch Canada Corporate Index. Yields fell to 3.3 percent from 3.33 percent on Sept. 20.
The premium investors demand for provincial debt compared to federal benchmarks fell one basis point to 72 basis points, according to the Bank of America Merrill Lynch Canadian Provincial & Municipal Index. Yields dropped to 3.1 percent from 3.12 percent.
Corporate debt has lost 0.8 percent this year compared to provincial debt’s 3.9 percent loss and the 2.9 percent declines for federal government debt.
Record Year
Goldman Sachs forecast issuance of catastrophe bonds to reach a record $8 billion this year as investors seek assets that are uncorrelated with most capital markets and offer higher returns than corporate debt.
Cat bonds are an effective way to transfer risk to capital markets, instead of reinsurance markets,” said Dickson, who heads the Office of the Superintendent of Financial Institutions. “Catastrophe bonds can be used to help companies to reduce exposure to” disasters such as earthquakes.
Alberta’s floods will be the costliest natural disaster in Canadian history, the Insurance Bureau of Canada said yesterday, when it estimated insured property damage at more than C$1.7 billion. Toronto’s heaviest one-day rainfall since 1937 on July 9, which knocked out power for 300,000 people and closed major arteries into the city, caused C$170 million of insurable damage.
Intact Financial Corp., the largest property and casualty insurer in Canada, said July 22 it will record losses of C$257 million from flooding in Alberta and Toronto. Sandra Nunes, spokeswoman for Intact Financial Corp., declined to comment on the potential of selling catastrophe bonds.
Canadian insurers have been absent from the catastrophe bond market mainly because they could get better rates through reinsurance of disaster risk, Kumar at Goldman said.
“Ten years ago it wouldn’t have made as much sense for them to come in this very exotic, very novel market when they could get pretty competitive rates in the reinsurance market,” Kumar said. “But the market has evolved so much that it is a very worthwhile proposition for Canadian insurers to explore.”
With assistance from Katia Dmitrieva in Toronto, Andrew Mayeda in Ottawa , Charles Mead in London and Theophilos Argitis in Ottawa. Editors: Dave Liedtka, Chris Fournier