cat bond

— Obtaining a financial rating is a critical step in issuing a CAT bond, because buyers use ratings to compare yields on CAT bonds with other corporate securities. Consequently, almost all bonds are issued with financial ratings. The ratings by bond issue volume from 2000 through 2006 are shown in Figure A9.7. The vast majority of CAT bonds issued in 2005 and 2006 have been below investment grade (ratings below BBB), that is, 93.0 percent of the 2005 issuance volume and 94.5 percent of the 2006 volume were rated BB or B. In 2007, there has been a resurgence in investment grade bonds (Swiss Re 2007a), although the majority of CAT bonds are below investment grade in 2007 as well. Although bond ratings lower than investment grade are generally bad news for insurers, reinsurers, and other corporate bond issuers, they are not necessarily adverse in the CAT bond market. Because CAT bonds are fully collateralized, CAT bond ratings tend to be determined by the probability that the bond principal will be hit by a triggering event. Thus, the bond ratings merely indicate the layer of catastrophic risk coverage provided by the bonds. In the past, the CAT bond market has been criticized for lack of investor interest. However, that assessment is now outdated—recent data suggest broad market interest in CAT bonds among institutional investors. Figure A9.8 shows the percentage of new issue volume by investor type in 1999 and 2007. In 1999, insurers and reinsurers were very prominent on both the supply and demand sides of the market and were among the leading investors in the bonds, accounting for 55 percent of the market. If insurers and reinsurers are on both sides of the market, the market cannot be said to have attracted very much new capital into the financing of catastrophic risk. However, by 2007, insurers and reinsurers accounted for only 7 percent of demand, suggesting that substantial external capital has been attracted to the market. Dedicated CAT funds accounted for 55 percent of the market in 2007, and money managers and hedge funds accounted for 36 percent. The declining spreads and increasingly broad market interest in the bonds suggest that the bonds are attractive to investors and are playing an increasingly important role relative to conventional reinsurance.