00:00Now as the world faces a growing number of natural disasters, one investment tool is attracting unprecedented interest from investors worldwide, catastrophe bonds or cat bonds.
00:13Now these are a form of insurance linked security. Investors lend money to insurers and if no major disaster strikes, they earn high returns.
00:23But catastrophe hits, part or all of that money is then used to cover the losses.
00:28This year's issuance has already shattered records, topping $18 billion and it's only August, surpassing the total for all of last year.
00:40So what's driving this boom? Well, mostly climate change, which is making disasters more frequent and of course more costly.
00:49And cat bonds offer very appealing high interest rates.
00:53The yields typically range from 5 to 10 percent, but some high risk options can pay up to 20 percent a year.
01:02Cat bonds move to a different beat from stocks and bonds.
01:05Their value depends on the weather mostly and it isn't linked with the financial cycles.
01:12Now Jean-Louis Monnier is senior executive at global reinsurance giant Swiss Re.
01:18Jean-Louis, thanks so much for joining us.
01:20I wonder if you could just take us through how these cat bonds work and how they're different from reinsurance.
01:28Yeah, effectively at the core, they allow transfer of insurance risk to capital markets.
01:34But in the middle, you have a special purpose vehicle to which the risk would be transferred into.
01:40And that special purpose vehicle then issues securities that investors can invest.
01:45And that special purpose vehicle raises money from investors.
01:49And this proceeds are invested in very safe collateral, which is there to pay the losses for the protection buyer.
01:57So this is a market that has been used by insurers and reinsurers, but also more recently countries and corporations.
02:04Now, cat bonds, I understand, sort of began in the mid-1990s after I think it was Hurricane Andrew.
02:11It seems it's mostly about climate, but it also worked during COVID, if I'm not mistaken.
02:16So how big is the market these days?
02:20So the cat bond market is, in terms of outstanding, $55 billion in capacity.
02:27The alternative capital markets, more broadly, that includes collateralized reinsurance and also sidecars, it's about, you know, $110, $120 billion,
02:40which is, you know, around 16% of the overall capacity which is being provided by reinsurance and alternative capital markets.
02:50So it is a growing share of the sessions are being transferred to investors in this way.
02:57I'm just wondering, you know, how investors judge a market that's essentially climate-controlled.
03:03And we know that climate risks are increasing.
03:08So surely as weather extremes increase, the risk of losing all your investment does as well, if there's a massive, massive claim.
03:16And yet the popularity grows.
03:18So maybe a few thoughts on that.
03:22The first one is that climate change is, you know, a long process.
03:28And the models, you know, usually are, you know, adjusted and adapted to try and accurately model the risk that is being seeded.
03:37So at the core, you know, you have the best view of, you know, scientific view of what the market is.
03:44So, and the second one is that if you look at the root cause for increase in catastrophic losses in recent years,
03:54most of it actually comes from two elements which are outside of, you know, climate change.
04:01One is demographics, the move of population in, you know, towards coastal and more risky areas.
04:08And the other one is inflation, rebuilding costs have gone up.
04:13So those two factors have contributed to an increase effectively in exposures and an increase in demand for risk capacity, especially in the U.S.
04:23I know that with increasing climate issues, you know, like massive fires or flooding,
04:28even during COVID we saw this, is that insurers were really worried that they wouldn't be able to actually pay their clients in the event of massive risks.
04:39And the questions being asked then are, well, essentially we'll get to a stage where you cannot insure because the risks are just too big.
04:48Despite all these vehicles to sort of cover the risk, do you think we're moving in that direction?
04:52So that's an interesting question because what we're seeing is that capital markets actually provide that additional pool of capital and capacity
05:02that allows the key peak payrolls to be seeded.
05:08And from a capital markets point of view, if you're a capital markets investor and you allocate a small proportion of your assets to, you know, insurance risk,
05:18you can actually withstand a loss, let's say your pension fund allocating 1% of your allocation,
05:26you could withstand a loss on that 1% as long as you have a long-term view and can recoup, you know, from the premium potential losses.
05:36So all I'm saying is that 55 billion is actually quite small compared to the trillions of capital that are available in capital markets.
05:44And there is room to grow, and we're very confident that capacity will be provided, you know, for the long term.
05:51And maybe one last point, if we look at how the market grows, it tends to be growing for those peak U.S. perils.
06:0170% of the risk seeded currently in carbons comes from U.S. hurricane.
06:07So the market is actually exercising that very role right now of being the complementary capacity to the reinsurance market
06:17for the riskiest of all perils.
06:20Thank you so much.
06:21Really interesting to chat to Jean-Louis Monnier, senior executive at Global Reinsurance Giant Swiss Re.
