TD Insurance’s debut of the first Cat bond in Canada could make this form of investment more attractive to other Canadian insurers, as it’s essentially “collateralized reinsurance,” Morningstar DBRS says in a new commentary.
“TDI could also reap some other intangible benefits such as enhanced brand recognition and a reputation for innovation, being the first insurance company in Canadian history to successfully issue a Canada-specific Cat bond,” authors at the credit rating agency write.
TD Insurance secured a three-year, $150-million Cat bond, effective from Jan. 17, 2025, to Dec. 31, 2027, the company announced in January.
A Cat bond is a security that pays insurance companies only when a predefined disaster risk occurs. For TDI, it provides companies under its banner additional reinsurance capacity to protect against earthquakes and severe convective storms. Its Cat bond has an indemnity trigger on a per-occurrence basis.
Through a Cat bond, risk is transferred to investors, who receive an interest rate over the life of the bond that “is greater than that of most fixed-income securities,” Morningstar DBRS authors explain. “If such a bond is triggered, the payout starts once the losses incurred by the issuer reach the Cat bond’s attachment point (the predetermined threshold amount that, once achieved, triggers a payout by the Cat bond).”
According to Artemis, TDI’s Cat bond offering would attach at $2.35 billion of incurred losses to TDI, and the coverage will be exhausted when incurred losses reach $2.5 billion.
“At a time of increasing costs, we’re always looking for ways to provide the best possible pricing to our customers, and this new bond is another tool at our disposal,” James Russell, president and CEO of TDI, commented when the Cat bond was announced. “At TD Insurance, being there for our customers during their time of need remains our most important focus, and the issuance of a Cat bond helps ensure we can continue to protect them when it matters most.”
Morningstar DBRS says Cat bond demand has grown globally in 2024 to nearly $50 billion in risk capital volume.
“[TDI’s] bond issuance timing seems appropriate, given that Canadian property and casualty insurers experienced the worst-ever year for insured severe weather-related losses in 2024, as well as the approaching spring thaw, which increases the risk of flooding across the country,” the credit rating agency authors write.
What there is to gain from a Cat bond
Morningstar DBRS says investor demand for Cat bonds remains strong with lower interest rates on the horizon. These bonds can provide investors with an opportunity to “diversify their portfolios while reaping significantly higher yields compared with some traditional bond instruments.”
Of course, Cat bonds are also beneficial to its issuers — insurers.
Cat bonds allow insurers to reduce their risk exposure to natural catastrophes without entering or renewing a reinsurance contract each year. As reinsurance policies need to be renewed yearly, having a Cat bond over a specific period like TDI does, makes coverage more predictable, DBRS says.
CAT bonds are typically backed by collateral and issued through a special-purpose vehicle (SPV) to reduce credit risk. The money raised from the bond issuance is invested in safe, liquid, and high-quality securities, which are held in a trust account.
If a covered natural disaster happens, the money is paid to the issuer through the SPV. If no disaster occurs, investors earn a return from the interest on the invested securities and the cost of reinsurance protection provided by the SPV, DBRS explains.
“Since CAT bonds are effectively collateralized reinsurance, they can also help free up or strengthen insurers’ regulatory capital positions, potentially helping improve their credit profiles,” the authors write. The debut issuance by TDI could make CAT bonds more attractive to other Canadian insurers.”
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