Increased cat bond duration a sign of ILS investor comfort: IAIS

The increased duration of insurance-linked securities (ILS) and catastrophe bond transactions in recent times is an indication of improved market sophistication, as investor comfort with the asset class increases, according to the IAIS.

Now that alternative reinsurance capital has become a common feature and force of the global reinsurance market, making up roughly 12% of overall reinsurance market capital by the middle of 2015, according to the International Association of Insurance Supervisors (IAIS), its permanence in the space following a large loss event has often been questioned.

However, the general view of reinsurance and ILS market analysts and participants has been that owing to the nature of the institutional investors that are providing the capital, and the sheer volume of it alongside traditional reinsurance capacity, it’s unlikely a significant amount of the funds’ and their capital will disappear following the next large loss event.

Further supporting this view, the IAIS draws on the fact that in recent years the tenure of catastrophe bond transactions, which make up the majority of the ILS market, is no longer as short, mainly since 2006.

Between 2004 and 2006, explains the IAIS, some cat bond issuers discovered more effective, and adequate pricing from smaller deals that had maturities of one to two years, although, “issuance based on the notional amount was higher.”

“After 2006, maturities tended to increase slightly. In 2014 and 2015, the average maturities increased though the sample size is smaller since more issuances have been completed without ratings. However, issuers continue to come to market with tenors of three years or more as investors have become comfortable with the asset class,” says the IAIS in its recently published, ‘2015 Global Insurance Market Report.’

The chart below shows average risk periods or durations of 144A catastrophe bonds by year. This data is taken from reinsurance firm Munich Re’s quarterly ILS report up to 2014 and then 2015 data is based on the full-year issuance recorded in the Artemis Deal Directory (excluding private deals and any longer life related transactions.)

Average catastrophe bond duration by year. Data sourced from Munich Re to 2014, Artemis for 2015

As alternative reinsurance structures, ILS and catastrophe bonds continued to be more widely used across new geographies and offer solutions for new risks, capital markets investors have increasingly gained a greater comfort and understanding of the asset class.

At the same time, ILS management teams, whether part of a dedicated ILS fund or a division within a re/insurer, or institutional investor, have also become much more sophisticated regarding the asset class.

A rise in investor comfort and willingness, and ILS management teams’ improved understanding and sophistication will ultimately help the product become more useful to cedents, which in turn will increase investor awareness and grow the market.

Furthermore, the “increasing maturity length is an example for a trend in the catastrophe bond and insurance linked securities market in the last couple of years towards sponsor or cedent-friendly structures,” advises the IAIS.

It’s been widely noted by reinsurance and insurance industry executives and analysts that alternative reinsurance capital is here to stay, and that it’s probably best to begin working with it now, in some capacity at least, so that you don’t miss the opportunity further down the line.

And it appears that’s exactly what some in the space have been doing in recent months, supported by the continued growth of the catastrophe bond market, which according to data from the Artemis Deal Directory now stands at just shy of $26 billion, the highest level ever recorded for the outstanding cat bond and ILS sector.

Another benefit of the increased duration of cat bond transactions, explains the IAIS, is that it offers issuers of such deals with some protection against rising premium rates, as they typically lock in protection for the predetermined tenure, at a predetermined rate.

“Investors are binding their capital, which provides some reassurance that alternative capital is here to stay for a longer period of time even in case of a major insured catastrophe event,” said the IAIS.

Looking forward, the IAIS expects conditions in the global reinsurance market to remain tough, competitive, and pressured.

Adding that alternative reinsurance capital “continues to seek a larger piece of the pie, but here to the pace of capital market capacity entering the market has seemed to slow and some collateralized markets have returned excess capacity to investors unable to find suitable opportunities to deploy their capacity.”

It will be interesting to see just how influential the ILS sector will be in 2016 and beyond, as the trend of increased sophistication, and a wider understanding of the asset class, its structures and benefits across the globe is expected to continue.