What happens to the Cat bond market after a major event?
While investors are attracted to the uncorrelated returns of cat bonds, the purpose of issuers is to obtain insurance coverage against low frequency and high severity catastrophes. Consequently, we will eventually face an event large enough to cause extensive losses in the re/insurance industry and the cat bond market. However, an event, such as a hurricane category 4 or 5 making landfall in Southern Florida, also tends to increase future returns for investors, as the insurance industry need to attract new risk capital.
Cat bonds can effectively and quickly mobilise risk capital for insurance protection. The recapitalisation of the traditional re/insurance market via equity and corporate bonds is slower and less flexible.
After a major catastrophe event the yields tend to increase in the cat bond market and in a typical cat bond fund.
In the longer term, an increased use of alternative capital is expected in the insurance industry via cat bonds and similar instruments for risk transfer. There has been a diversification of the perils on the market in the past years and this development could be accelerated by a hardening of the re/insurance market. For investors, this would not only entail increasing returns, but also improve and further extend the diversification opportunities within the cat bond sphere.