While both the average rate-on-line and the excess return of insurance-linked securities (ILS) and catastrophe bonds declined considerably in 2014, it was at a slower rate than that seen in 2013, according to the latest report from Lane Financial.
ILS consultancy Lane Financial’s synthetic rate-on-line index, which takes data from both the ILS and ILW markets to provide a reasonable approximation of premiums being paid (or rate-on-line) for ILS and cat bond transactions, has been on a general decline since its high point in 2009.
A slight blip in 2011/12 which saw the index rise after the heavy losses suffered in catastrophe reinsurance was quickly reversed from early 2012 onwards, as the influence of inflows of alternative capital alongside lower reinsurance pricing drove the index down.
At the end of 2014 the rate-on-line index stood at 86, down from 87 at the end of Q3 2014, so a decline of just over 1%. For the full-year of 2014 the index dropped by around 7.5% from 92.9 where it finished 2013. However the decline has slowed considerably. In 2013 the ILS rate-on-line index fell by a massive 27%, from 127.1 at the end of 2012 to 92.9 at the end of 2013.
The chart below, taken from Lane Financial’s Q4 2014 Market Performance Report, shows the slowing decline in ILS rates-on-line in 2014.
So, with two years of low catastrophe losses now behind us we can compare the way the RoL index has responded to market conditions. It seems clear that ILS shed much of their rate in 2013 and that 2014 has not seen as much of a decline in premium across the market of ILS, catastrophe bond and industry loss warranty (ILW) instruments that Lane Financial track rates for.
Similarly, the excess return of the outstanding ILS and catastrophe bond market while down in 2014 has not declined as fast as in 2013, according to Lane Financial’s report.
At the start of 2013 the excess return of the outstanding ILS market, or the return available between average expected losses and the average yield spread, was 5.14%. That shrank right down to 2.9% by the end of 2013, a decline in excess return of a huge 44%.
This year however, after beginning at 2.9%, the excess return has ended the year at 2.36%, so declined by 19% over the course of the last year. In fact, during the last quarter of 2014 the excess return actually bounced back slightly, likely reflecting the changes in secondary spread created by robust market activity and issuance at the end of last year.
This trend in terms of the excess return of the catastrophe bond and ILS market is reflected in Artemis’ own chart which shows the spread between average expected loss and average coupon. As you can see below, the decline in spread between the two was much slower in 2014.
Artemis’ chart showing the average multiple of issued catastrophe bonds and ILS by year also reflects this trend as the multiple, which to a degree displays the level of return per unit of risk assumed, has declined much more slowly in 2014 compared to the prior year.
Lane Financial also tracks the average multiple at market, defined as the secondary yield versus the expected loss at issue. Its latest report shows that the decline in multiple in 2014 was at a much slower rate than the year before and that in Q4 2014 it actually ticked up slightly.
According to Lane Financial’s report the ILS market has been in a softening state since mid-2012. The softening was at its most evident in late 2013 and early 2014, but in the second half of 2014 particularly towards the end of the year this softening has slowed down.
This corresponds with the fourth-quarter trend for catastrophe bonds and ILS to more commonly reach final pricing at the mid-point, or even above, of guidance. This continues to suggest that ILS investors feel a pricing floor approaching and have slowed down their discounting of risks. As a result, this reflects a level of discipline in pricing as ILS investors find a point they are not happy to go below.
However, all of these metrics are at or near lows, which continues to demonstrate the appreciation of the efficiency and lower-cost of ILS capital being wielded by ILS investors. It will be interesting to see whether the rate-on-line index gets back to the lows last seen in 2005 or whether ILS investors find their floor and these metrics all begin to level off. After that it will also be interesting to see how they respond to losses and the reinsurance market cycle in the future.
You can access the full report from Lane Financial via its website here.