The catastrophe bond market proved to be a pretty safe place to invest last year, notwithstanding the damage Hurricane Sandy inflicted on the eastern seaboard of the U.S.

Swiss Re’s global catastrophe bond index posted a total return of 10.28% for 2012, helped by the strong performance of the largest deal ever. The market closed the year with record outstanding issuance of $14.6 billion, bolstered by $5.45 billion issued in 2012.

“This strong performance has occurred during a period of historically low interest rates paired with broad uncertainty in the global economy,” Swiss Re said in a report published March 1.

Catastrophe bonds are a form of reinsurance; if the issuer suffers a loss from a particular, pre-defined catastrophe, its obligation to pay the interest and repay principal may be deferred or completely forgiven.

The Global Index’s return was bolstered noticeably by the State of Florida’s $750 million Everglade Re, issued in April, which represented 5.7% of the index’s market value and paid a spread of 17.75%, adding approximately 0.91% to the index’s 2012 return.

“The bond carries a high coupon and so weighted up the income of the index substantially,” said Luca Albertini, chief executive of London-based Leadenhall Capital Partners.

Everglade Re also illustrates a trend toward riskier deals, including those with indemnity triggers that more carefully reflect the net losses stemming from catastrophes.

“In 2012 this trend became more pronounced as investors accepted more complex risks including aggregate indemnity, commercial indemnity and residual pool risk,” the Swiss Re report notes.

Increased demand from institutional investors streaming into the market in search of diversification and attractive yields is a big factor. Illustrating this appetite for additional yield and its accompanying risk, the Everglades Re offering started out at $250 million as was inked at triple that size. By year-end, indemnity triggers made up 44% of the Global Index’s market value, an all-time high.

“Whenever there’s great demand for issuance, issuers will continue to develop and push the boundaries of structures to see what the market is willing to accept,” said Craig Bonder, a fixed-income analyst at Maxim Group.

The Swiss Re report notes that the indemnity-based structures resemble coverage provided by traditional reinsurers. “To the extent that the cat bond market is able to accept these types of risks on an indemnity basis, the market may be able to gain access to a broader array of insurers,” it says.

The report says that a number of cat bonds with exposure to Hurricane Sandy were marked down following the storm, with prices reaching a low on Nov. 16. Since then, however, spreads have tightened steadily, and the storm does not appear to have been hindered new issuance.

Swiss Re’s Global Index has provided an annualized return of 8.32% since it was launched in 2002, compared with the S&P 500 Total Return Index’s 3.85% return over the same period, although the S&P 500 index logged a 16% return in 2012. The Barclays US High Yield index has yielded 8.74% since 2002 and it tallied 14.59% in 2012.

Catastrophe bonds are marketed not just for their relative returns, but for their lack of correlation with other financial markets and the diversification that this provides.

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