After reporting that the decline of average catastrophe rates-on-line for insurance-linked securities (ILS) and catastrophe bonds was slowing in its last report, Lane Financial has now found that rates in ILS markets have stopped falling and may even be rising (a little).
This is news that the ILS and cat bond market players and investors will be pleased to hear, providing further evidence that ILS managers and investors have been seeking to establish a pricing floor and in fact may now have succeeded.
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, actually rose by one point in the last quarter.
Having been on a general decline since 2011 any upward momentum is seen as a potential sign that the pricing floor has been reached. The synthetic rate-on-line index rose from 86 at the end of 2014 to 87 at the end of Q1 2015.
Lane Financial notes that the change is small. The last time the index turned up was at the end of Q2 2014. However looking at the index, it now sits only just below the level where it was at the end of Q1 2014.
Adding some confirmation to the measure, Lane Financial notes that for the first time since September 2012 the market value of the outstanding basket of ILS and cat bonds that they track was trading at a discount compared to its issue price. Something which would suggest pricing has floored and may even rise.
Lane Financial explains:
In a softening market investors who have lately joined the market or missed an issue allocation pay up to gain securities or lock in old rates, thereby pushing up prices. The market trades at a premium to book.
When securities are not being chased or investors are willing to wait to deploy at better prices the market trades at a discount to book. That appears to be the case for the first quarter of 2015.
Lane Financial notes that the discount is small at the moment, and would only become notably large in the event of capital being lost or drained from the market, which would signal a hard market, something they say there is no evidence of.
Of course, the price shift could be seasonality, they caveat, and the expected seasonal down turn in Q2 could be manifesting earlier than normal. While rates continue to decline in traditional reinsurance, as annual renewals catch up, Lane Financial believes that the ILS market looks further ahead.
“The secondary market is now looking beyond the present quarter and the message seems to be – yields have done falling,” the report explains.
They also note that prices on riskier tranches of notes may have risen, while those on the least risky tranches may have been falling. This shows that investors are targeting the higher yielding tranches resulting in greater competition for them. The rate-on-line index tracks this and reflects that activity, and shows that it is level or rising, the report says.
Lane Financial also note that while the market has shrunk, as ILS issuance could not keep up with maturities in Q1 2015, investors are not putting upward pressure on prices by trying to redeploy increasing volumes of capital. Again, this would indicate a leveling.
They also note that they believe that the advance of looser terms on ILS issuance has stalled, something else that investors will be pleased to hear.
The most telling is perhaps the leveling off of the index over the last twelve months, as it has been almost a year since the first discussions of a floor nearing began. That now appears to have been prescient as the floor is beginning to become easier to see.
Whether this persists, or we see more declines in ILS rates in future quarters, will have to be seen over the longer-term. However if the ILS and catastrophe bond market can establish a floor and stick to it, it could help to slow or even stop the erosion of returns that are being experienced, which will certainly be welcomed by investors.
Download the full report from Lane Financial via its website here.