Catastrophe bond pricing becoming decoupled from reinsurance market pricing

Catastrophe bonds are having a great year so far with issuance hitting record levels in the first quarter and extremely healthy in Q2, details on all the cat bond deals to come to market can be found in our Deal Directory. The wider financial press has been complementary about this growing market and cat bonds are becoming more widely seen as a viable reinsurance alternative, an efficient form of risk transfer and a great alternative investment asset.

One of the recent articles which interested us is this article, published Sunday, on the Investment News website. There are a number of comments from Chi Hum of Guy Carpenter in the article which are worth highlighting.

He said that users of reinsurance capacity are increasingly looking at catastrophe bonds and valuing the different attributes they offer. The collateralized nature of cat bonds and multi-year programs have proved attractive enough to bring new issuers into the market (such as Florida Citizens and Louisiana Citizens). The ability to lock in a reinsurance rate over a number of years brings predictability and stability to the reinsurance purchasing cycle for these issuers. Chi Hum also notes that with cat bonds as a component in an overall risk transfer program it can give cedents leverage in getting better pricing from reinsurers. This suggests that cat bonds are becoming seen as competition for traditional reinsurance which is definitely encouraging for the market.

Interestingly Chi Hum states that cat bond pricing is becoming decoupled from traditional reinsurance pricing which he sees as a positive development for the cat bond market. He credits investors motivations for this decoupling as investors are driven by a completely different set of pricing drivers than reinsurers.

Traditional reinsurance pricing from is known to be driven by the risk profile of the overall portfolio of catastrophe risks that a reinsurer underwrites combined with the usual risk/location specific factors, market pricing trends and modelling. Could pricing of catastrophe bonds and ILS become driven by demand and appetite for investing in risk along with supply-side factors such as issuance volumes and the actual return-period or probabilities that a deal is modelled with? This would suggest that what we have here is more akin to a capital market than a reinsurance market which should be a good thing for further growth and development of the cat bond and insurance-linked securities sector. The article quotes Chi Hum as saying that this is a good development as they believe it would be positive if cat bond pricing could be viewed independently.