Bird flu continues rapidly to infect the world’s media, if not yet its population, spawning feverish headlines about the human and monetary costs of a potential pandemic and somewhat more absurd stories of how happiness or Sauerkraut could guard against the illness.

But signs of the seriousness of the threat are evident in capital markets, where there is growing interest in the potential for reinsurers to pass on to investors – in the form of so-called catastrophe bonds – the costs associated with a sudden rise in deaths.

Swiss Re sold $762m of catastrophe bonds in two issues in April this year and at the end of 2003, to cover extreme mortality risk in its reinsurance of life companies, of which an influenza pandemic is a significant part.

“We have seen significantly increased interest in transferring mortality risk, which is partly influenced by all the discussion in the media surrounding a potential influenza pandemic,” says Shiv Kumar, of the financial institutions structured finance group at Goldman Sachs.

“More and more life companies have been transferring mortality risk to reinsurers, so there is now a concentration of that risk.”

Catastrophe bonds have so far mainly covered severe wind storm or earthquake risks mostly in the US. Bondholders lose money only if reinsurers suffer extremely high losses on the risks specified in the bond.

Investors in one such bond – a private placement named Kamp Re – have incurred losses due to Katrina, the hurricane that led to the flooding of New Orleans. However, most investors in the $6bn market remain untroubled, in spite of two years of heavy US storm-related losses for reinsurers, and there is scope for further market growth.

A confluence of factors, including investor demand, rising reinsurance premiums and the needs of reinsurers to secure capacity to exploit higher premium rates could be about to spark a quickening of issuance, according to specialists at Swiss Re Capital Markets and Goldman Sachs, the two main underwriters of such deals.

“We recently closed a [$300m] transaction, the first since Katrina, which demonstrated that investors continue to be interested in the sector,” says Michael Millette, head of financial institutions structured finance at Goldman Sachs.

“A pipeline is building up that is substantial. We see an expansion in the market that could lead to the same kind of step up in issuance that we saw after 9/11, which could mean issuance of $3bn or more per year.”

Judith Klugman, managing director at Swiss Re Capital Markets, says that even before Katrina $1.5bn of bonds had been issued in 2005. “There is a robust pipeline, I think this could be one of the highest ever years for issuance, beating the $2bn in 2003,” she says.

This is tiny compared with insurance industry losses from the 2004 hurricane season in the US of about $20bn and losses from Katrina alone of more than $30bn, according to Fitch, the ratings agency.

But Ms Klugman adds that it will take time before the effects on catastrophe bond issuance of the recent hurricane losses can be seen. However, she says investors are becoming interested in taking on riskier bets.

This could mean a bigger appetite for indemnity-type catastrophe bonds, which cover cumulative losses for a reinsurer and so must pay a higher coupon, as opposed to parametric-type bonds, which are triggered by specific events, such as very high winds in Florida.

But Mr Millette adds: “Post Katrina, because of some uncertainties about the counting up of losses, indemnity-type bonds will now attract more investor scrutiny than parametrics, which allow claims to be settled much more rapidly.”

Some parametric bonds are linked to industry-loss indices and these are among the most likely to be facing losses now. While only three public catastrophe bonds have ever experienced losses, one person in the industry says more private deals have done so and a number of reinsurers will be collecting on industry-loss parametrics, often from hedge funds.

There are other options available to securitise risk, which some in the industry predict will see stronger growth than catastrophe bonds.

Hannover Re last week announced a €500m securitisation plan to help revive its fortunes after being the latest in the industry to report huge hurricane losses. The group is to draw up a more traditional reinsurance contract but will place it in a special purpose vehicle funded by cash from investors such as hedge funds.

Such a deal mimics the trend for hedge funds and private equity to finance individual Bermudan reinsurers, attracted by the higher premiums that follow years of heavy losses.

Rodrigo Araya, analyst at Moody’s, is cooler on catastrophe bond growth.

“There has been some pressure for issuance from the capital markets, but it takes time and is expensive,” he says.

“But there could be a new trend in selling extreme mortality risk, because of worries about an influenza epidemic.”

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