ILS and reinsurance pricing need to converge to boost issuance

by Artemis on October 14, 2010

As we all know, reinsurance pricing has been softening of late and this means there is plenty of reinsurance capacity available at good prices for insurers to snap up. This has been making the insurance-linked security and catastrophe bond market seem more expensive and less competitive as an alternative hedging mechanism, but perhaps that trend is beginning to change.

Baldwin & Lyons have issued their October update for their fund and market commentary today and in it they discuss pricing equivalence (or lack of). They raise a very interesting point that “some have suggested that insurers should be wiling to pay a premium to access the ILS market”. There does tend to be a premium on first time issuances to the capital markets and this could well be hindering ILS market growth, says the report. Baldwin & Lyons say that they have “always been skeptical of this suggestion and consider this “novelty premium” to be one of the factors limiting growth in ILS”. Their expectation however is that pricing will converge over time and increased capacity will help to stabilize both markets.

The report notes that issuers who set up a program of recurring catastrophe bond deals will find pricing cheaper on the second and subsequent issuance. A good example of this is the recently marketed Calypso Capital Ltd. deal which is just the first portion of a large program which could be used for further issuances. This smart forward thinking approach could reap dividends for the issuer AXA over the coming years, enabling them to push out further notes more cheaply (and probably more quickly). The report also points out that ILS is starting to take pricing cues from reinsurance in cases where the coverage is similar and cites Green Valley Ltd. as a good example of a more reasonably priced issuance.

Finally, Baldwin & Lyons say that they expect the trends of convergence and price softening to continue which will result in an environment conducive to increased issuance in 2011. Current trends in pricing will make the ILS market more attractive to insurers and as a result they expect the range of perils securitized to broaden which will be very attractive to investors in the market.

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