ESG cat bonds: a highly promising alternative product
Insurers and reinsurers use catastrophe – or cat – bonds to safeguard against natural disasters. Issuers are increasingly incorporating ESG commitments into such bonds, which is helping to attract a wider number of investors, and bodes well for continued growth in this niche asset class.
The number of natural disasters – whether floods or hurricanes– has increased fivefold in the space of 50 years(1), increasing the risks borne by both insurers and reinsurers. According to a recent report by France Assureurs, the French insurance federation, on the effects of climate change for the industry out to 2050(2), claims resulting from climate events in France could reach €143bn between 2020 and 2050, 93% higher than in the period from 1989 to 2019.
Cat bonds are one of the solutions that insurers and reinsurers are turning to in order to reduce their exposure to risk and address these increasingly frequent severe climate events.
Cat bonds: attractive financial instruments
Cat bonds emerged in the mid-1990s after two natural disasters in the United States – hurricane Andrew in Florida and an earthquake in Northridge, California. They are part of the broader Insurance-Linked Securities (ILS) segment. Cat bonds have an average maturity of three to five years and display specific features depending on the geographies covered – North America, Europe, Asia and Latin America – while covering three main categories of risk: earthquakes, wind events (storms, hurricanes, cyclones) and secondary risks such as floods, hail or forest fires.
In the event of a disaster, the investor loses all or part of the investment, but if the disaster does not materialize during the period of the cat bond, the investor recovers the initial investment at maturity, in addition to the coupon already paid out each year. Investors should therefore diversify their coverage by both geography and risk type.
These financial instruments now account for around 15% of the overall reinsurance market and provide an attractive source of diversification for investors looking for higher yield. They also offer an investment alternative to more traditional products, which are more likely to be affected by stock market fluctuations, while still offering attractive returns.
Development of a new ESG cat bonds segment
Insurers and reinsurers are looking more closely at the green cat bonds segment considering the challenges currently raised by sustainable development, the maturity of green and sustainability bond markets – which have surged 70% per year between 2016 and 2021 – and with a view to addressing investor interest in green products.
This new cat bond model incorporates an issue framework, as the issuer pledges to meet several ESG criteria according to market standards and a range of measurable impact indicators for them through regular reporting.
This model thus offers clearer visibility for investors and affords proof that their investment is being used appropriately, complying with the usual transparency and impact requirements in line with sustainable finance criteria.
“The reinsurance sector is a key link in the insurance industry chain and plays an important role in financing the real economy more broadly. In this environment, it is worthwhile exploring all opportunities to incorporate transparency and impact aspects into these structures to usefully connect the management of climate change and extreme disaster risk on the one hand with the contribution from funds raised to the financing of projects that clearly combat the effects of these changes on the other” states Julien Duquenne, Global Head of Sustainability & CSR for Global Financial Services (Natixis CIB, Natixis IM), Groupe BPCE.
Against this backdrop, insurers GENERALI and SCOR mandated Natixis CIB and GC Securities, a division of MMC Securities LLC, for their cat bond issues. GC Securities is an affiliate of reinsurance broker Guy Carpenter.
Natixis CIB acted as co-arranger, joint bookrunner and sole green coordinator for GENERALI in a €200m issue, and as sustainability advisor and joint bookrunner for SCOR in a $240m deal.
GENERALI decided to issue a cat bond to cover losses in respect of natural disasters in Europe and pledged to invest the capital from this transaction in green insurance projects and products, following the principles of its Green Insurance-Linked Securities Framework. Meanwhile SCOR highlighted its integration of ESG-related considerations to support investors' due diligence. This new cat bond issue offers the group multi-year risk transfer capacity to protect against the risk of named storms in the United States, earthquakes in the United States and Canada, and windstorms in Europe.
“The success of these operations required a combination of multiple areas of expertise, which is why we worked in close cooperation with broker GC Securities. Natixis CIB has developed longstanding expertise in ESG aspects, while GC Securities has a comprehensive view of the traditional insurance market to support clients, particularly on positioning of cat bonds and the hedging required”, states Nicolas Mérigot, Head of Global Structured Credit and Solutions, France at Natixis CIB.
Quentin Perrot, managing director at GC Securities adds: “Adapting cat bonds to take account of investors’ interest in ESG aspects will help increase the market’s interest in this asset class. So, we hope that this will help insurance and reinsurance companies continue to safeguard their business against natural disasters at reasonable cost despite climate change. This adaptation is set to take place gradually over the years ahead and will require major development efforts, combining ESG expertise and knowledge on the transfer of insurance risks. By working in partnership with Natixis CIB, we can help our clients make progress on this track”.
2 "Impact du changement climatique sur l’assurance à l’horizon 2050"
To find out more, view the video from our Natixis CIB experts Nicolas Mérigot, Julien Duquenne and Quentin Perrot from GC Securities.