The bonds are used by the insurance industry to lay off extreme risks, such as those for earthquakes or hurricanes, to financial market investors, who receive a handsome yield in return for agreeing to cover damages they consider unlikely.
Henning Ludolphs, head of the insurance-linked securities (ILS) team at the world's fourth-biggest reinsurer, said cash had been pouring into hedge and insurance funds in recent months that needed to be invested in catastrophe bonds. "We will see a higher amount of cat bonds coming to the market in 2010 but I don't think we will be back to the level that we saw in 2007," Ludolphs told Reuters in an interview.
Ludolphs said rival Munich Re's forecast of $5 billion in new cat bond issuance this year was largely in line with his own expectations. Ludolphs' team at Hannover Re, which helps insurance companies launch the bonds, also saw them as potentially useful for governments responding to emergencies like the 7.0 magnitude earthquake that hit Haiti on Tuesday. "If there are huge catastrophes it would allow a lot of money to flow in quickly which could be used for first aid programmes, for example," he said.
Ludolphs' unit is working on various concepts but does not plan any cat bonds in the next few weeks.
"We don't have anything in the pipeline on a larger scale right now, meaning $50 million and higher," he said. The company also has already bought the risk cover it needs for itself and nothing further is planned now, Ludolphs added.
The financial crisis has had a chastening effect on the sector, even though catastrophe bonds are seen as popular with investors precisely because insurance risks are not correlated with financial market ones.
Before the crisis cheap financing was used to leverage investments in the bonds, but now that funding has dried up. "Because investors need to have a minimum return and they can't get third-party financing, they need to accept higher risks in order to get higher nominal returns," Ludolphs said, adding that this meant the average expected loss on bonds being issued had risen slightly.
"I would hope for the ILS market that investors would look at risks at spreads down to 4 percent or even lower," he said, noting that current spreads to reference interest rates, typically Libor, were at 5 percent or more.
Catastrophe bond sponsors and investors have also made changes to the way the securities are set up to avoid credit and counterparty risks, after the collapse of Lehman Brothers hit some of the bonds with which it was involved. "My personal view is that the issue is resolved. There are structures available that will mitigate the problem," Ludolphs said.