LONDON, April 11 (Reuters) - The newfound popularity of specialist bonds linked to natural disasters has knocked investment yields down to all-time lows, cutting costs for insurers of events like hurricanes and earthquakes.
Insurers have used catastrophe bonds since the 1990s to manage their exposure to natural disasters by transferring potential losses to investment funds.
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The investor returns generated by these bonds have dropped by 22 percent, traders say, as demand for assets with income streams that are uncorrelated with other more mainstream securities continues to soar.
The cost to insurers of issuing cat bonds has fallen by up to 70 percent in 2013.
“If you compare a bond that was issued in 2007 and today with the same risk profile, spreads are at their tightest right now,” Judith Klugman, head of ILS distribution and sales at Swiss Re.
A recent bond issued by U.S. insurer State Farm, Merna Re IV Ltd, closed with an interest spread of 2.5 percent - the lowest threshold for minimum spreads in five years, according to Aon Benfield.
Spreads are the amount of cash that investors make from the coupons, or interest payments, they receive for investing in a cat bond. If they are tight, it means the spread over a reference rate is getting less.
Investors typically see average returns of up to 8.5 percent for cat bonds, but not enough deals are being issued quickly enough to keep up with demand.
So transactions have been heavily oversubscribed - pushing yields down by up to 22 percent compared with last year, according to Swiss Re data.
Pension funds and money managers have flooded the cat bond market chasing uncorrelated and high returns.
“We’re seeing spreads being very tight and new bond coupons much lower than we can believe,” said Sandro Kriesch, a partner at Zurich-based fund manager Twelve Capital.
One cat bond deal closed in March by Florida’s largest property insurer Citizens Property Insurance Corp, is the most aggressive example of downward pricing in the sector’s history.
The $250 million bond, Everglades Re Ltd, covers the insurers from hurricanes in Florida.
Even though this bond covers more risk than an identical transaction issued by Citizens last year, the bond priced at 10 percent above U.S. money market yields compared with 17 percent last year.
Despite cat bond returns being at their lowest, they are still “better than what investors can get in the wider financial markets,” Klugman said.