Validus Holdings Ltd. (VR:US) plunged the most since February after Credit Suisse Group AG (CSGN) downgraded the reinsurer on the prospect that potential clients will instead turn to catastrophe bonds for protection against disasters.
The reinsurer fell $1.39, or 3.9 percent, to $33.85 at 4:15 p.m. in New York, the second-biggest decline of the 218 companies in the Russell 1000 Financial Services Index. Credit Suisse’s Michael Zaremski cut his rating (VR:US) on the Bermuda-based company to neutral from outperform and lowered his price target by 5 percent to $38.
Fixed-income investors have increased demand for catastrophe bonds, which insurers such as Travelers Cos. and American International Group Inc. (AIG:US) use as an alternative to traditional reinsurance. The securities pay hundreds of basis points more than benchmark yields to investors who risk losing all of their principal to an insurance company if a costly enough natural disaster strikes.
“Cat bonds will continue to make inroads into primary insurers’ reinsurance programs,” Zaremski wrote. “Reinsurance has become more of a commodity due to lower barriers to entry and vendor models.”
The securities have climbed 3.7 percent since the beginning of last June, according to the Swiss Re Cat Bond Price Return Index. The measure tracks dollar-denominated debt sold by insurers and reinsurers.
Hedge-fund managers have been setting up reinsurers, and Wall Street has been creating new ways to bet on the weather. The trend has led Franklin “Tad’ Montross, chief executive officer of the General Re unit at Berkshire Hathaway Inc., to say new sources of funds are relying too heavily on catastrophe models in making pricing decisions.
The models have “lent an aura of credibility” to pricing, Montross said at a conference this month. “Anyone who’s in the industry knows that the models are always wrong. Directionally, they’re helpful, but we are trying to price a risk today that we do not know the cost of.”
“Validus has previously acknowledged the competition from third-party capital, but continues to assert that we are among a very select group of companies that has the skill set and existing platforms to adapt and thrive in the changing reinsurance market,” the company said in an e-mailed statement.
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