Average expected losses of the cat bond market relatively static in 2012: Lane Financial

The average expected losses, as measured at deal issuance, of the outstanding catastrophe bond market remained relatively static throughout 2012, according to data from insurance-linked securities consultancy Lane Financial LLC. In its latest quarterly ILS market update report data shows that the average expected loss has risen by just .01 over the course of the year. The same chart shows that the average secondary market spread rose by 0.15 in 2012.

Average expected losses of the cat bond market had been on the rise, according to Lane Financial date, steadily increasing since the end of 2008 when it had dropped to a low of 1.83. The average expected loss is now approaching the high point seen at the end of 2006.

The average expected loss is a good way to think of the risk appetite of the cat bond investment market, as it signifies the mid-point of all transactions issued that year. Of course some cat bond deals will have a much higher expected loss, and investors will receive a higher coupon yield for those bonds, while others will be less risky with a lower expected loss. The market appears to be around a sweet spot at the moment where yields now react to capital inflows and expected losses have been remaining more static.

The average expected loss was 2.44 at the end of 2011 and that has only risen to 2.55 at the end of 2012. Over the course of the year, however, spreads fluctuated and saw a sharp rise in Q2 which was related to the activity in the primary market and inflows being put to work in new deals, reducing secondary activity. During Q3 of 2012 spreads decreased again back to the levels seen at the start of the year and then in Q4 a very slight rise was seen which was probably a reaction to Sandy. While spreads and yields moved, expected losses remained relatively static across the year.

The average yield sits around the 7.50% mark by the looks of the chart below, while the average spread, was 5.14% at the end of 2012.

Catastrophe Bond Arithmetic Average Secondary Market Yield Spreads and Average Expected Losses (as Issued)

The other interesting metric to look at alongside this is the average multiple at market of catastrophe bonds, a figure which denotes the multiple of expected losses to yield. There’s long been a generally held opinion that multiples of 2.5% to 3.5% are common depending on the riskiness of a cat bond, and the chart below would seem to agree with the average multiple sitting around the 3% mark at the end of 2012. As you can see from the above, the average multiple fluctuates in line with spreads.

Average catastrophe bond multiple at market

Since the end of 2009 both of these charts show the market seemingly finding its sweet spot, with expected losses, spreads, yields and multiples remaining much more static, even through the last harder market in 2011. This shows the market maturing, knowledge and acceptance of risk in catastrophe bond form becoming much more widespread and investors clearly becoming comfortable with putting down capacity for risk around a certain level of expected losses for a certain return.

Read our other articles covering some of the highlights of this report:

– Insurance-linked security rates rise slightly, returns recover from Sandy in Q4

– 2012 cat bond market saw annual return 58% above average

You can download a full copy of the quarterly ILS market report on the Lane Financial website where you’ll need to register to download a copy.