Asset managers the world over are forever on the lookout for higher returns. They are also attracted to uncorrelated asset classes – hence the rapid growth in interest in catastrophe bonds and insurance-linked securities.
Here is an asset class with returns calculated on extreme weather events rather than interest rates or commodities or real estate – and therefore truly uncorrelated. For instance, the Swiss Re Global CAT Bond Total Return Index showed a return of 19.7% last year, in part because there were fewer Nat CAT events.
The question arises – why is there little to no CAT bond and ILS activity in the Middle East?
The market is dominated by US risks, which represent almost 80% of the total. The balance is spread across Europe, Japan and Australia and New Zealand. CAT bonds and ILS covering other areas are rare.
While there are other interesting developments in this arena, such as cyber-CAT bonds, most serious ILS market players are currently waiting on the sidelines and monitoring possible developments in MENA.
Expert opinion received by Middle East Insurance Review suggests that looking for CAT bonds/ILS market activity in the region is ‘premature’ since the market is non-existent for various reasons.
There has been some suggestion that one impediment to the development of the market in the region is the potential requirement to ensure that the instruments are shariah compliant – the implication being that the future might see the development of CAT sukuk.
But the truth is that this is likely to be of marginal significance in the early days.
The ILS market is (almost) uniquely confined to the cover of natural catastrophes and the reason for this is that such perils can be modelled. If perils can be modelled with precision, then the ILS structures and CAT bonds can be assigned a credit rating.
If the credit rating is investment grade, this opens the door for the big institutional investors like pension funds to participate in the offering – which is why CAT bonds are such a big hit in the US.
For the ILS market to develop in the Middle East, there would have to be a number of significant structural development – such as more granular modelling of natural perils like flood and earthquake. Windstorm/sandstorm, another natural peril to plague the Middle East, cannot be modelled with any accuracy and so is unlikely to underpin future ILS.
The commercial reality is that few disaster modellers are likely to spend much time and effort on modelling perils in the Middle East until there is significant growth in primary non-life insurance.
And this is the nub of the problem. The market simply is not yet big enough in terms of primary P&C cover to make it worthwhile for modellers to develop simulations - and so there never could be a rating assigned to an instrument aimed at covering the risk.
Without a rating there will be few investors interested in exposing their capital, irrespective of the returns promised. M
Paul McNamara
Editorial director
Middle East Insurance Review