The latest quarterly insurance-linked securities and catastrophe bond market report from Willis Capital Markets & Advisory (WCMA) was published late last week. The ILS market report looks at the issued and marketed deals which launched in the first-quarter of this year and discusses some of the emerging trends in the sector. WCMA sees a strong pipeline of catastrophe bond deals ahead and said that it expects a record year of issuance in 2013.
“After a slow start, 2013 is roaring forward with a flurry of cat bond, sidecar, and collateralized reinsurance activity,” said Bill Dubinsky, Head of ILS at WCMA.
According to the report, new capacity is helping to drive forward the ILS, cat bond and collateralized reinsurance sectors growth, with the two key sources of this growing third-party reinsurance capacity being new inflows to existing ILS specialist investment managers coupled with the return of generalist investors.
Bill Dubinsky continued; “Collectively, capital markets insurance capacity significantly outsizes the surplus of the leading non-life reinsurers, excluding Berkshire Hathaway. Meanwhile, almost all major Bermuda reinsurers, except one, have third party capital initiatives in place. We may be witnessing the moment when the capital markets have moved from the sideshow to the main tent.”
The new capacity is being added to capital from existing investors who are reinvesting capital from matured cat bond deals and returned collateral from collateralized reinsurance trades in both new collateralized transactions and the new cat bonds that have come to market. In contrast, WCMA says that the generalist investors (both new to and returning to the asset class) value the price discovery of syndication and the transparency and liquidity of a bond structure. This is resulting in a clash of capital from these two sets of investors, said WCMA, and as a result cat bond spreads have been dropping rapidly.
We’re now at the point where the long predicted divergence of cat bond spreads from traditional reinsurance pricing has occurred, with the cost of capital driving spreads particularly in U.S. hurricane risk deals, according to the WCMA report. We would also add that investor acceptance of the asset class has risen leading to an increased appetite for risk at lower returns as investors show their willingness to undercut traditional reinsurance pricing.
WCMA explains in the report; “This makes sense since the cost of capital for a traditional reinsurer to put its regulated and rated balance sheet to work in peak zones is quite high. In contrast because of the power of diversification over a larger portfolio and the absence of direct rating agency and regulator constraints, investors can make money even with the reduced spreads.”
WCMA is certainly bullish on the potential for catastrophe bond issuance to reach record levels in 2013. It says that sponsors are lining up to access protection and that if this trend persists, as WCMA expects, then the pipeline should convert to record issuance through the rest of the year. WCMA already sees insurers and reinsurers gearing up to issue deals in the second half of the year.
A side effect of the reduction in pricing on capital markets cover such as catastrophe bonds will likely be for an eventual knock-on effect that makes insurance more affordable and available, which in turn will generate increased demand creating what WCMA term a ‘bigger pie’ for everyone.
The report discussed the sustainability of third-party capital and whether it will be sticky or not. WCMA is pragmatic in saying that some investors will no doubt leave the market, but then others will enter it, and that this is a sign of a mature market, a sentiment we wholeheartedly agree with. The report then follows that with one of the finest quotes we’ve seen on just how big a deal this reinsurance and capital market convergence could really become, in our opinion:
Is reinsurance being transformed by the capital markets in the same way as the Internet and cellphones have transformed the publishing industry? Perhaps some reinsurers lacking differentiating underwriting expertise are on their way to becoming the next Encyclopedia Britannica.
We believe it is an accurate comment to compare the impact that third-party capital is having on the reinsurance market to that level of disruption within an industry. The impact that the internet has had on publishing is enormous and it has led to new business models, delivery mechanisms and platforms being launched. The reinsurance industry will likely see similar levels of change as it evolves over the coming years. As we’ve written before, this ‘fast capital‘ isn’t going away quickly so it is time to get used to a ‘new normal‘ in reinsurance.
The industry is reacting with reinsurers ‘hedging their bets’ by launching their own third-party capital management facilities and initiatives. At the same time WCMA says that primary insurers are wondering who will be around to provide them reinsurance capacity in years to come and that some think that now is the time to begin developing new relationships and new sources of capacity. WCMA says that for insurers it is choice that is the real source of sustainability and it is not a case of simply clinging on to tradition.
Large specialist ILS investment managers are beginning to look a lot like big reinsurers in the way they are choosing to enter into private capital market transactions, arranging their own private deals and putting themselves in front of syndications to lock in capacity. This is akin to large reinsurers who lead or dominate on reinsurance line slips, often managing to lock out competitors in this way. We wonder how long it will be till ILS and capital market capacity begins to lock out the large traditional reinsurers, perhaps that’s already happening to some extent on recent Florida wind deals especially.
This syndication by investors on cat bonds and capital markets deals is something that brokers like Willis and their primary insurer clients understand the importance of though, and WCMA stress that while single investor, or private deals, have a role to play syndication is where brokers can really add value. Of course as capital markets deals grow in prevalence the broker role may morph to be more akin to the cat bond bookrunner in the future and as we all know there are investors in the market now who can structure, underwrite and close deals on their own if they choose to.
It’s a particularly bullish report this time from WCMA, which shows that the brokers are beginning to position themselves as capital markets focused just as traditional reinsurers are also trying to do. Similarly, the recent report from GC Securities also went a lot further than before in talking up the ILS and capital markets reinsurance space. This is a further sign that the market itself expects this convergence of third-party capital markets capacity and the reinsurance market to continue and become the norm.
The report also features discussion of the Q1 2013 cat bonds issued and marketed as well as an interview with LGT’s Michael Stahel. You can access the full WCMA ILS Quarterly Q1 2013 report via the WCMA website here.