If companies can’t get enough insurance against natural disasters at an affordable price, will they turn to insurance-linked securities to manage the risk?

Many market participants think the answer is ‘yes,’ – and soon.   

To date, most issuance of bonds transferring risk of property damage to investors has come from insurers who are looking for an alternative to reinsurance. Yet climate change is bringing an increasing incidence of floods, windstorms and other kinds of extreme weather, requiring corporate issuers to pay ever more attention.

In fact, participants expect that more catastrophe bonds or collateralized reinsurance transactions from corporate issuers are imminent, given currently attractive pricing that puts ILS in competitive reach of traditional insurance products.

“No such deals have occurred [yet this year], notwithstanding the favorable conditions for sponsors,” said William Dubinsky, managing director, head of ILS at Willis Capital Markets & Advisory. “Nonetheless, we continue to see strong interest from individual insureds and expect one or more significant deals to occur by year end.”

Yields on cat bonds have fallen to all-time lows, so any deals from corporate issuers are likely to be met with strong demand. “Compared to other fixed-income markets, ILS still provides attractive returns, and it’s one of the few markets to generate returns that are uncorrelated” to the overall financial markets,” said Craig Bonder, managing director at AK Capital, an institutional broker.

Corporate issuers may find that the risks associated with extreme weather can affect their cost of capital. Major investors and asset managers, such as Franklin Templeton and the California Public Employees Retirement System, have developed teams to promote incorporating the risk into investment decisions, and the rating agencies have recognized the risk as well.

“Climate event risk has the potential to damage profitability, impair asset value, and constrain cash flow. This can weaken a company’s liquidity position and compromise its ability to raise funding and service debt over both the short term and long term,” Standard and Poor’s said in a May 21 report. “Corporate credit quality may suffer if companies do not implement adequate risk management measures regarding climate events.”

The report goes on to note that, “The increasing frequency of extreme weather events such as flooding, intense storms, heat waves, and cold snaps is putting pressure on companies to identify, quantify, and disclose the material risks related to such events.”

Michael Wilkins, managing director, infrastructure ratings at S&P, said that, to date, corporates have relied mainly on insurance to mitigate risk related to climate change, and insurers have handled that risk adeptly. However, insurers’ capacity is limited.

“The corporate world has some way to go in terms of managing risk, but it must be looked at carefully because it’s potentially going to have a big impact on their creditworthiness,” Wilkins said.

There have already been a few ILS transactions by entities other than insurance companies. The New York Metropolitan Transportation Authority issued the first storm surge deal in July 2013, after Hurricane Sandy flooded several tunnels, and it was well received by investors. The offering was upsized by 60%, to $200 million, pricing at a coupon of 4.5%.

S&P’s report documents the most recent, and dire, findings about the impact of climate change. Allianz, for example, found that weather and climate directly or indirectly affected $5.7 trillion of the U.S. economy in 2012, representing more than 30% of GDP. Meanwhile, Munich Reinsurance recorded 888 loss-related natural catastrophe events worldwide in 2013, down slightly from 2012, but above the 10-year average of 822, and significantly higher than the averages in the 1980s and 1990s.

S&P cites agriculture as the industry most at risk from climate change, while oils and gas, power, property and water at are high risk. The National Research Council and the Global Change Research Program assess U.S. energy infrastructure as significantly at risk. For example, oil and natural gas extraction and processing infrastructure tends to be located near coasts, making it vulnerable to severe weather and rising sea levels. Electricity transmission and distribution infrastructure is susceptible to severe weather and may be stressed by rising demand for electricity as temperatures rise.

ILS yields increased a bit in May, after steadily falling over the last year, and further increases could damp some of their luster for new issuers. Bond noted, however, that performance has been very strong in recent years and shows little sign of diminishing.  “Even after a small price stabilization, ILS is still a very attractive market for issuers at the moment,” Bonder said.

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