A window has now been opened to reinsurance pricing by the introduction during the last decade of Insurance Linked Securities (ILS), such as catastrophe bonds. These bonds, distributed broadly to investors in the capital markets, contain catastrophe risk and have explicit prices associated with them. They also associate premiums with a risk analysis. To the extent the embedded risks are typical of the traditional market the components of price can now be forensically examined. Since inception in 1996, in excess of 250 separately priced ILS tranches have been issued and priced. These bonds contain a wide variety of catastrophe perils. The principal peril classifications are windstorm and earthquake risk in the US, Europe and Japan. These have been complimented by others including earthquake risk in Mexico and Guatemala, and windstorm in the Caribbean. This set of perils is quite representative of the traditional reinsurance market as a whole.

This paper has found that the long term average over the whole set of bonds (1997 – Q1 200) is 2.69 times the expected loss. The most recent issues of the last five years show an average of 2.87. Whether this is too high is not a subject of discussion here; clearly these are freely derived market prices, so they are correct if we assume that these markets are competitive.

There is suggestion that the multiple will decline over time as the ILS market becomes more and more competitive. However, this is not a conclusion that can be easily drawn from the data. Simple multiples differ according to the point in the cycle; the level of risk attachment; the peril and zone; the risk profile of the coverage; and how it diversifies or concentrates the existing portfolio. Stripping out the volatile elements of the hard/soft market reinsurance cycles indicates that the cycle-adjusted multiple is estimated at 2.33.

Differentiating by peril shows that the multiple for US Wind peril is a relatively high 2.78 plus a cycle adjustment. On the other hand, Japanese wind shows a multiple of 0.88 plus the cycle adjustment. This is strong evidence that diversification pays. Japanese Wind deals appear to get a diversification credit from the market, i.e., they are priced at less than expected loss (when cyclic components are excluded). Similar remarks appear to apply to other non-peak perils.

Further detailed examination of these phenomena is conducted at two points in time using secondary market prices and Industry Loss Warranty (ILW) prices instead of the time series. This view points to the volatile nature of the markets. In the last hard market, June 2006, the capital load as represented by the long-term average multiple was 3.34. The most recent, first quarter 2008, was 1.68. And, correspondingly, the peril-specific multiples change dramatically between periods. US Wind peril falls from 3.45 to 2.4. US Quake falls from 4.47 to 2.19. Similar effects are perceived in the more diversifying perils. In other words, there is even a diversifying credit that is not immune to the larger capital market cycle.

The capital cost in a transaction is also affected by the profile of the embedded risk. Thus a deal with a long tail in its risk distribution may require more capital than one with more concentrated outcomes. Risk profiles are best summarized by risk measures such as Standard Deviation and Tail Value at Risk. This paper shows how higher capital loads are associated with higher risk measures. This, too, varies by cycle.

Catastrophe reinsurance prices, as represented by the ILS market, are determined freely in the capital markets. Dissecting the prices reveals that any ILS price is a function of a) expected losses, b) the wider capital market cycle, c) the risk profile of the transaction, d) the perils contained.

This paper has not proposed, nor discovered, any new models of catastrophe risk pricing behavior. Instead it has pulled together data from a number of disparate, and sometimes proprietary, sources to examine 19