US ratings agency Fitch has predicted a surge in the issuance of catastrophe bonds after the September 11 disaster, with the market potentially exceeding $2bn in 2002.

In a newly-released special report, Fitch believes cat bonds will be a more competitive alternative as traditional insurance becomes more expensive and less available.

"Fitch expects significant increases in traditional insurance rates, significant declines in available capacity and modest declines in perceived insurer financial strength as a result of the disaster.

"The changes in these three factors will tend to make cat bonds a more competitive alternative," said the report. Fitch said it believes rising rates in the cat bond market will somewhat dampen the enthusiasm of sponsors but overall it maintains the forces behind increased cat bond issuance outweigh the forces against it.

Fitch said it also expects the higher spreads offered by cat bonds relative to similarly rated alternatives will attract additional investors. Fitch noted that the share prices of publicly traded property/casualty insurers have risen markedly as investors anticipate higher returns from rising premium rates. And Fitch believes a follow on will be investors will be drawn to the cat bond market in anticipation of higher returns.

If there is a surge in cat bond issuance, the agency expects it will follow the historic pattern of reinsurers first issuing cat bonds to obtain retrocessional coverage. Fitch also believes the potential surge in cat bond issuance relates only to property exposed to natural catastrophes, such as earthquake or hurricane risk. "In order for cat bonds to work, independent modellers must be able to estimate a probability of loss that both the sponsor and investors accept as reasonable. Such models for earthquake and wind risk are well accepted.

"However, Fitch believes it is nearly impossible to credibly model the human behaviour element as it relates to events like those of September 11," it states.