Cayman ever more attractive for cat bonds

June 2013 | EXPERT BRIEFING | RISK MANAGEMENT

financierworldwide.com

For many years Cayman has been a true heavyweight and the leading domicile for sponsors of cat bonds and other insurance linked securities. But where does the sector stand today, particularly in light of Cayman’s recently enacted new Insurance Law?

The cat bond market is an important component of Cayman’s financial services industry. Typically, you tend to think of Cayman in the context of banking, hedge funds and captive insurance, but it is less well-known that Cayman is the largest domicile for cat bond issuers ranking ahead of Bermuda, Dublin and Switzerland. The first Cayman cat bond was issued in 1996 and this discrete sector has continued to flourish ever since. A remarkable statistic is that Cayman issuers account for approximately 90 percent of all cat bonds issued since the mid-1990s. Of the 20 transactions issued in the first seven months of 2012, 13 of them were by Cayman domiciled issuers representing US$2.6bn of the US$4.3bn issued at that time. So, Cayman has a huge piece of the market.

New Insurance Law

Cayman’s new Insurance Law is an important and welcome development to the cat bond sector. The new Law reflects a comprehensive modernisation of Cayman’s insurance legislation in alignment with international standards and addresses a number of different issues from enhancing protection for policyholders in Cayman’s domestic market, to the establishment of a specific regulatory regime for open market reinsurers. So far as cat bonds are concerned, the Law established for the first time a separate category of licence for cat bond issuers. Previously, for an issuance which involved reinsurance as opposed to a finance contract, the only option was to seek a class B licence which is the licence category for captive insurers. Cat bond issuers were somewhat shoe-horned into a category of licence that was not really designed for them. It worked but was not ideal. Now, under the new Law, the new class C licence is available which is specifically designed for cat bond issuers and other special purpose insurers. This is a great improvement which recognises the important of the sector, and demonstrates Cayman’s appetite to attract further business and maintain its leading position on the global stage.

As with the other categories of licence under the Insurance Law, the holder of a class C licence is subject to regulatory oversight and supervision by the Cayman Islands Monetary Authority (CIMA) and is required to file audited financial statements with CIMA within six months of its financial year end. These requirements obviously provide a level of comfort to investors in the issuer. In addition, the holder of a class C licence must be a Cayman Islands exempted company with at least two directors and, absent a permanent place of business in the Cayman Islands, which would be very rare, it must appoint a Cayman-based insurance manager to handle accounting and other administrative matters. Under the old Insurance Law where the only option for an issuer was to seek a class B licence, the licence application form was not well-suited to the circumstances of a cat bond issuer but now there is a tailored application form for a class C licence which certainly helps to make the process simpler and more efficient.

Capital requirements

Whilst CIMA has the discretion to require enhanced capital, the minimum capital requirement for a class C licence is a modest US$500. The prescribed capital requirement is also US$500. The Insurance Law describes the prescribed capital requirement as total risk-based capital that an insurer must maintain in order to operate in a safe and sound manner. In other words, it is a prudent level of capital having regard to the risks which are written. This modest capital requirement is a reflection of the nature of the financial product and, in particular, that the substantive capital to meet the obligations assumed by the issuer is derived entirely from the investors. Prior to the creation of the class C licence, a regulated issuer had to maintain capital of at least US$120,000 even though there was generally no particular need for such a level of capitalisation.

The licence fee for the class C licence is US$6098 and this is paid on first licensing and annually thereafter. Again, this compares favourably with the old regime under the class B licence where the licence fee was US$10,366. So, there is a worthwhile cost saving.

Cayman Islands’ Stock Exchange

The Cayman Islands Stock Exchange’s (CSX) involvement in the cat bond sector has been extremely important. A significant number of programs are listed on the CSX for a variety reasons, including tax, regulatory and marketing. The CSX’s first cat bond listing was in 1997 and by February 2012 the CSX had reached the major milestone of its one hundredth cat bond programme and series listing, with a total face value of around $8.5bn. Cayman’s ability to offer the complete package, including a listing facility, has clearly proved very attractive to many sponsors. There has been an interesting recent further development. The CSX has signed an agreement with Deutsche Boerse to use its XETRA trading platform. This platform is to be used for the full trading and transfer of listed cat bond and ILS notes. This will add a further dimension to Cayman’s offering since, traditionally, trading in these securities has been ‘over-the-counter’.

The future

The cat bond sector seems to be very robust at present. 2012 was a bumper year globally. According to Aon Benfield, new catastrophe bond issuance for Q4 2012 reached $1.89bn, and $6.25bn for 2012 as a whole – the highest insurance-linked securities issuance volume since 2007. Particularly in the current economic climate, cat bonds are attractive to institutional investors because of the lack of correlation to the traditional markets. On the sponsor’s side, these programmes offer reinsurers an alternative source of capital to supplement their traditional capacity.

Without wishing to tempt fate, the indications so far are that 2013 could be another good year for the sector and with its new regulatory regime in place under the Insurance Law, its solid track record and highly experienced service providers, Cayman should be in a strong position to continue to see a significant proportion of the new business coming through.

Paul Scrivener is a partner with Solomon Harris. He can be contacted on +1 345 949 0488 or by email: pscrivener@solomonharris.com.

Paul Scrivener

Solomon Harris