Catastrophe Bonds Rise for Sixth Week on Forecast

Catastrophe bonds, used by investors to bet against natural disasters, rose for six straight weeks as the forecast for an “extremely active” U.S. hurricane season was scaled back.

The Swiss Re Cat Bond Price Return Index rose 0.5 percent to 95.27 on Aug. 20, as investors bet insurers are less likely to collect on the securities. It was the biggest increase in 10 months for the benchmark, which is recalculated each week.

Insurers including American International Group Inc. and Travelers Cos. sell the bonds as an alternative to reinsurance for natural disasters. If there are no catastrophes, bond buyers stand to benefit. The U.S. Climate Prediction Center cut its forecast on Aug. 5 for the hurricane period to 14 to 20 named storms, down from 14 to 23 on slower-than-expected activity in the first two months of the season.

“Going into the season, there were very dire predictions,” said Chi Hum, global head of insurance-linked securities distribution at GC Securities, a unit of MMC Securities Corp. “At least the early stage doesn’t seem to be that active. If this carries through September, that creates a situation where the value of bonds should go up.”

The climate center, a unit of the National Oceanic and Atmospheric Administration, reduced its May outlook because only two named storms, Hurricane Alex and Tropical Storm Bonnie, formed in June and July, according to the group’s website.

‘Real Meat’

“There was reason to doubt the forecast because not much has happened so far,” said Joe Bastardi, chief meteorologist at AccuWeather Inc. “On the other hand, things could turn around quickly. The real meat of hurricane season has yet to arrive.”

Tropical Storm Danielle may become a hurricane within a day, the U.S. National Hurricane Center said. Danielle had maximum sustained winds of 60 miles an hour, according to an advisory on the center’s website at about 4:45 a.m. Miami time, and was over the Atlantic at about 850 miles west of the Cape Verde Islands, heading west-northwest on a course that won’t take it near land for at least five days.

Twenty storms this year would make it the third-most-active season on record. The most-active season saw 28 storms in 2005, when hurricanes Katrina and Rita hit the Gulf of Mexico.

The center said in May the June-to-November storm season may be “extremely active,” boosted partly by La Nina, a weather pattern that reduces high-altitude winds, which impede Atlantic storm development.

Record Gains

Catastrophe bonds gained a record 5.2 percent last year on a season that didn’t produce a named storm until Aug. 15. The Swiss Re index, which doesn’t reflect interest payments, fell 7.3 percent in 2008 as hurricanes Ike and Gustav struck and Lehman Brothers Holdings Inc. failed.

Fixed-income investors earn more than benchmark rates for taking the risk they could lose their principal in the event of a disaster that meets pre-defined conditions.

AIG’s Chartis property-casualty unit issued a $425 million cat bond in May through Lodestone Re, a special-purpose entity, in its first purchase of reinsurance via capital markets. The bond’s $250 million slice will pay 8.25 percentage points more than three-month Treasury bills. The second slice yields 6.25 points above the benchmark.

“As more money needs to find a home in cat bonds, prices get bid up, spreads tighten,” said Peter Nakada, managing director at risk-modeling firm Risk Management Solutions Inc. “Last year was an anomaly because of the financial meltdown.”

Proceeds from cat-bond sales are invested in collateral such as government bonds that is used to pay interest to investors and payouts to the bond’s seller if a pre-defined disaster occurs.

Swiss Reinsurance Co., Allianz SE and Chartis were among sellers of a total of almost $2.5 billion in cat bonds this year as of Aug. 20, about a 50 percent increase from the same period in 2009, data compiled by Bloomberg show.

To contact the reporter on this story: Inyoung Hwang at ihwang7@bloomberg.net.

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