Cat bond market still constrained by size of opportunity & costs

The global catastrophe bond market has experienced impressive growth in recent years and continues to claim a larger slice of the overall reinsurance market pie. However, some feel it is unlikely that the market will double in size from where it is today.

According to Artemis’ data, the size of the outstanding catastrophe bond market (including related life ILS and mortgage ILS deals) sits at roughly $37.2 billion, with issuance in 2018 already at the $12.8 billion mark, meaning full-year issuance will set new records.

The Artemis Deal Directory and Artemis’ quarterly Catastrophe Bond & insurance-linked securities (ILS) Market Report’s show that over the last few years, catastrophe bond issuance has often reached new heights. But according to Credit Suisse, it’s unlikely the market will continue to experience this level of growth moving forward.

According to an analyst at Credit Suisse Asset Management’s recent ILS investor conference, while double-digit growth has been the trend, the market is nearing a limit to growth because most of the insurance or reinsurance risk that makes sense to be transferred to the ILS space has already done so.

“Therefore, CS (Credit Suisse) doesn’t see the CAT bond market doubling from today’s levels,” said Credit Suisse research analyst, Michael Zaremski.

To date, the catastrophe bond market remains heavily focused on the property catastrophe arena, and most notably the U.S. marketplace, although efforts by the World Bank and other organisations has seen the geographic footprint of the space expand into other parts of the world, such as Latin America.

At the same time, the volume of deals covering mortgage insurance risks has been on the rise in recent times, while transactions offering protection against financial guarantee risks and operational risks have also been a feature of 2018.

Furthermore, pure wildfire risk and U.S. flood risk (from named storms) also featured for the first time in the cat bond market’s history in the third-quarter of 2018.

So, while the cat bond market clearly remains focused on the U.S. property catastrophe space, investors in the space appear willing and able to assume more exotic and new risks, both within the property cat space and also in longer-tail lines, such as mortgage insurance. All of this suggests further steady expansion.

The protection gap (disparity between economic and insured losses post-event) remains substantial across the world, and this includes the U.S., which is among the most insured places on earth.

The opportunity for ILS to deepen its presence in the U.S. market is clear, underlined by the recent flood and wildfire transactions, but there’s also potential for ILS to influence emerging markets as insurance penetration rises.

While it’s impossible to tell how large the catastrophe bond market might get, it’s clear that investors are eager to make the most of uncorrelated and diversified returns in both mature risks/markets as well as more emerging ones.

Doubling in size from today’s levels would be quite something for the cat bond market, and while it might be the case that the accelerated growth seen in recent times slows, there’s clearly potential for the cat bond space to continue to expand its remit and ultimately claim an increasingly larger slice of the overall reinsurance market pie.

However the Credit Suisse analyst hits on a valid point, that growth of the catastrophe bond market is likely to be constrained by the availability of the types of risks most suited to transfer in this 144a securitised form, as well as by the size of the overall reinsurance and retrocession markets.

Hence future growth of the catastrophe bond market is likely to be aligned with the growth of insurance and reinsurance penetration, as well as the appetite of sovereigns and corporates, unless meaningful expansion into other classes of business can be achieved.

Of course the other aspect of the market that constrains the growth of catastrophe bonds remains the cost and complexity of issuance.

If meaningful steps could be taken to lower costs and make issuance a simpler and smoother task, with a less steep learning curve involved, then significant growth of catastrophe bonds could be seen.

For while a range of factors do constrain the size of the cat bond market today, financial innovation, technology and the continued appetite from investors to invest in insurance-linked risks with secondary liquidity should ensure that this slice of the ILS market does grow, although perhaps largely in-step with other re/insurance market growth trends.