ILS to expand, new issuance spreads likely to improve: Twelve Capital

The catastrophe bond and insurance-linked securities (ILS) sector performed well for investors during 2015, and analysis from Twelve Capital predicts further innovation and expansion during the coming months, while spreads are also expected to improve.

In what was a volatile year for the broader financial markets, catastrophe bond transactions continued to show their benefits and efficiency as an asset class with low-correlation during 2015, “in mitigating mainstream financial risks whilst also offering attractive risk premiums to investors,” says insurance and reinsurance linked investment manager, Twelve Capital.

2015 saw some new perils and trigger frameworks come to the cat bond, collateralised reinsurance and ILS landscape, and Twelve Capital feels this trend will continue and even accelerate as 2016 gets underway, “resulting in innovative new structures benefiting both cedants’ risk-transfer requirements and investors alike in our view,” advised Twelve Capital.

Much discussion in the ILS and cat bond space has circulated around its ability to access new risks and enter new geographies, something that has been limited due to a lack of modelling capabilities, product/market understanding and local industry knowledge.

However, as the asset class continues to grow in terms of capacity and maturity, with investors willing to increase their understanding of ILS solutions and their benefits, along with improved sponsor sophistication and understanding of the sector’s potential scope, it’s apparent the market is poised to continue down its impressive growth path.

Rates across the insurance, reinsurance, and wider risk transfer landscape came under significant pressure during 2015, as a benign loss environment combined with low interest rates, increased competition and ample capacity, limiting the profitability of the majority of firms.

However, with regards to pricing developments in the cat bond and ILS space, Twelve Capital notes that pricing appeared to stabilise throughout 2015 when compared to the previous years, “and we believe that no material change will take place during the first half of 2016,” says the firm.

In fact, Twelve Capital predicts “that spreads at issuance for diversifying perils and remotely attaching Cat Bonds with a yield range of 2.0-3.5% have reached their lows from a risk-adjusted pricing perspective and that spreads are likely to improve for new issuances in 2016.”

While for transactions offering investors a coupon in the mid-single digits, Twelve Capital expects pricing to be “closer to current trends.”

After numerous discussions with market participants the insurance-linked investment manager expects new cat bond issuance to be strong in the first half of 2016, as the high level of maturing deals should be offset by renewals and the entry of new sponsors to the market.

Furthermore, Twelve Capital notes the recent growth in private transactions, or cat bond lite deals, which are typically smaller in size and more efficient to structure than a 144A cat bond.

The firm expects the maturing of the market and growth of private ILS deals to continue throughout 2016, “with many cedants feeling comfortable transferring risk via these structures and investors receiving improved levels of diversification and enhanced returns from previously inaccessible risks.”

The outstanding cat bond and ILS space achieved outright growth again in 2015, and investor confidence appears to be growing all the time, despite the lower available yields. The asset classes’ low correlation to the wider financial markets clearly remains attractive to investors, particularly at times of financial sector volatility. As does the potential for stable, diversifying returns over the longer-term.

As the entire risk transfer landscape continues to expand its understanding of new exposures, and new geographies, something that will be supported and driven by enhanced technology and modelling capabilities, it’s likely the ILS sector will broaden its reach and have an influence outside of its current scope.

And with the possibility of rates improving in the ILS space, while interest rates remain low and margins across the insurance and reinsurance sector remain thin, it’s possible that this could spark the interest of new sponsors and investors, seeking to access the returns of a beneficial, diversifying, and relatively uncorrelated asset class.