The reasoning behind Canada’s first Cat bond

Although the likelihood of triggering Canada’s first-ever Cat bond is low, the investment gives TD Insurance options to diversify its protection sources, the insurer’s president and CEO, James Russell, said during a webinar Tuesday.

TD Insurance sponsored the first-ever Canadian-denominated Cat bond in January 2025, covering Canadian perils of earthquake and severe convective storm in the amount of $150 million. The bond is triggered at the indemnity level of $2.35 billion in losses, to a cap of $2.5 billion.

There’s a very “infrequent probability” this particular bond would be triggered, Russell acknowledged during the Morningstar DBRS webinar.

To put it into perspective, Canada’s record-breaking 2024 Cat loss year of $8.9 billion had only two individual events that exceeded $2 billion in insured losses: the Calgary hailstorm (about $3.25 billion) and remnants of Hurricane Debby ($2.7 billion).

Options to diversify

“While the likelihood of reaching this level of catastrophe is very low due to the expectancy of a catastrophic event of this magnitude occurring, this investment gives us options to diversify our protection sources,” Russell said during the webinar.

TD Insurance’s Cat bond is in place for three years (from Jan. 17, 2025 to Dec. 31, 2027) with an annual reset feature, and cannot be reinstated like traditional reinsurance. Through the life of the Cat bond, noteholders are paid the risk spread and interest earned on the collateral, Russell explains. If the bond is not triggered, the collateral at market value is returned to the noteholders at the end of the term. If it is triggered, investors stand to lose some or all of the principal, depending on the nature of the event.

The process of sponsoring a Cat bond is quite complex, taking more than 12 weeks from initiation to execution in TD’s case, Russell said. The insurer worked with regulators, third-party experts, third-party catastrophic risk model vendors, and legal counsel, among others.

“The preferred approach is for a Canadian-denominated catastrophic bond offering with the collateral held in a Canadian reinsurance security account and then invested in high-quality Canadian dollar-denominated assets such as money market funds,” Russell says.

However, it’s less common for a large Canadian money market fund to generate sufficient interest among global investors, he says. “Thus, for the Cat bond to meet that criteria of a high-quality collateral and comply with Canadian regulatory requirements, a puttable floater with the European Bank for Reconstruction and Development, or EBRD, was identified as a collateral solution…”

Russell noted a strong end to 2023 attracted broader interest from investors in the alternative capital space.

“And following the shift in the traditional reinsurance market from 2022 and 2023, we started to think about the untapped sources of reinsurance capital, which could supplement coverage provided by the traditional reinsurance markets…” he says. “As the frequency and severity of natural catastrophes increases, it’s very important that we evolve our approach [to] stay ahead of those last trends.

“We look at this new Cat bond as another tool at our disposal to diversify sources of protection and provide the best possible protection and pricing to our clients.”

Follow the leader?

Being the first Cat bond in Canada also creates an opening for future investments from TD or peers, Russell adds.

Victor Adesanya, vice president of global insurance and pension ratings at Morningstar DBRS, believes the demand for Cat bonds will grow in the future.

“Cat bonds have had strong performance over the past couple of years, starting from 2023…up ‘til now,” he said during the webinar. “I think you have a strong demand for Cat bonds going forward.

“We expect demand to grow on the investor side.”

Since Cat bonds have a low correlation to traditional investments — for example, the outcome depends on the occurrence or non-occurrence of a specific event — typical market events don’t affect a Cat bond, Adesanya adds. “That low correlation gives a good mix to a portfolio.

“For the investors, there’s a need to diversify the portfolio,” he says. “I think that also helps them on the insurance side. Additional cover is provided for the insurer or the reinsurer beyond their reinsurance limits, so it gives more cover beyond the traditional insurance program.

Adesanya expects more insurers will follow TD’s path. “I think the personal lines insurance companies…will also find it quite attractive, because they are the ones that are more exposed to aggregate losses when they have a major storm hit the community.”