In our second of this series of Artemis interviews we are delighted to have been able to speak with another well known figure from the insurance-linked security and catastrophe bond market. Christophe Fritsch, Head of ILS at AXA Investment Managers, has been involved in the market for a number of years and created their insurance-linked securities team. The interview follows below.
How do you think the cat bond market is fairing currently?
The cat bond market is fairing quite well, as demonstrated by the good performance of cat bonds, as well as the relatively steady issuance of volume. Still, the market needs to get much deeper if it wants to secure ongoing interest from investors. We believe it will.
How do you see the investor landscape changing?
When you look at who invests in the cat bonds market, you see that there are not that many institutional investors that have gone into it, often because they think it remains too shallow for the time being and not liquid enough. For the market to really get going once and for all, large investors such as pension funds and insurance companies will need to be much more present in this investment universe. This will create a new market dynamic as it is likely to spur even more issuances if the necessary conditions are present.
What do you think needs to happen to encourage more investors and institutional capital to the market?
As I just said, the market needs to keep on growing so as to attain a critical mass that will enable the kind of liquidity institutional investors are looking for. This will create a virtuous circle that is likely to accelerate the development of the market. For this to happen, sponsors must in part think in terms or structure, especially after the cat bond default caused by Lehman Brothers in 2008, which has shed light on the structure of cat bonds. Investors want to have a clear understanding of how a cat bond works, both in terms of underlying perils and structure, the latter coming along with its own set of risks. This is a definitive calling for a transparent, more straightforward structure, as well as easier access to transactions on the secondary market. As a matter of fact, investment opportunities can sometimes be jeopardized because of that. You don’t want to invest in a transaction you don’t fully understand. Moreover we need to see more issuance; when you see that the cat bond market size is approximately only 5% of the Cat Reinsurance market size, there is room for improvement.
What do you think will help to encourage more new issuers?
From an issuer standpoint, the reduction in the gap between the market reinsurance premium and the capital market premium will help. Also, the imminent implementation of Solvency II is driving insurers to think about how they will meet the new requirements, and insurance-linked securities are part of this reflection. Cat bonds can present an opportunity for alternative capacity.
What do you see as the attractive features of ILS for investors and issuers?
For investors, it is mostly the low correlation of cat bonds to other asset classes as well as to the global economic cycle. As a matter of fact, cat bonds have posted a strong performance throughout the crisis, which gives substance to the theory behind cat bonds.
How do you think cat bonds can help the recovery of the structured credit market?
The good performance posted by cat bonds demonstrated that structured credit, depending on the underlying risk and how it is structured, can be fairly resilient in the face of a crisis and can bring much value to an investor’s portfolio. Investors are slowly but surely getting convinced about the value cat bonds can bring to a portfolio. From the relatively small niche market cat bonds are, they will become more mainstream, an integral part of the structured credit market.
How do you see the market developing?
I expect the ILS market to continue growing; by 2016 the cat bond market could turn around USD 30-40bn outstanding, and this number does not account for the larger ILS market, within which mortality and longevity risks will find natural buyers amongst the investor community. There is a two-way relationship between the insurance sector and economic growth. That is, economic growth calls on for more ever more insurance capacity, and economic growth brings more insurance capacity. With places such as China and India, as well as other emerging markets undergoing strong economic growth, this can only be positive for the insurance sector, and ultimately for an increase in cat bond issuance.
Where do you see the ILS market going in terms of innovation?
Probably towards the securitization of new perils such as Motor, Aviation, etc…. However, the development of such perils face significant hurdles in terms of modelling since there is at the moment no external vendor model that is available for investors. In other words, for investing in such cat bonds, you would need access to your own internal models. This significantly reduces the number of possible investors or intermediaries.
Any fears for the markets future?
My main fear is that the liquid and broadly sold market remains limited to natural catastrophes. The technology that has been developed for natural catastrophes could be extended to other lines of business.
Any threats/risks you see the market being exposed to that participant need to be wary of (both short term risks and longer term)?
Market participants need more discipline. That is, cat bond investments need to become systematically included in portfolios, and sponsors need to start issuing cat bonds in a much more steady way, without leaving the market when spreads are high, and getting back when spreads get tighter.
Any thoughts on regulation with particular reference to Solvency II?
This is a positive development for the market as it will encourage more sponsors to come forward while searching for alternative capacity. Some insurance companies may even be induced to invest in cat bonds given the favourable treatment of cat bonds in terms of regulatory capital.
What trends do you see emerging?
Larger insurance markets will ultimately lead to a broader array of diversified cat bonds in terms of regions and perils. And for the cat bond market to continue retaining investors’ interest, it will have to diversify.
What is AXA IM’s strategy regarding ILS and do you see that evolving going forwards?
Our strategy is to continue to offer fund products and to manage money for third parties in this sector. We became one of the first institutional investors to invest in ILS because we believe the market will develop tremendously and that view has not changed.
We’d like to thank Christophe for his time and the insight into the market he’s provided!
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