Today saw reinsurer Swiss Re hold their annual insurance-linked securities (ILS) media event at their London offices, where they presented their thoughts on how the ILS, catastrophe bond and reinsurance convergence markets have progressed during 2012. With Swiss Re Capital Markets themselves playing a leading role in the ILS and cat bond space, it is always interesting to hear their opinion on the topics which we’ve discussed over the course of the year here on Artemis.
The core of the event was a review of the year to date in the non-life catastrophe bond market, presented by Martin Bisping, Head Non-Life Risk Transformation at Swiss Re. We’re going to focus on this presentation here and will follow-up with other insights from the event over the coming days.
Swiss Re see 2012 as the year that the cat bond market returned to growth. According to their metrics, which as regular readers will be aware may differ from other companies who report on the sector, the outstanding ILS and cat bond market has been shrinking ever since 2007 when it hit a peak of $17.3 billion of risk capital outstanding at year-end. After a healthy year of issuance in 2012 the market has achieved outright growth this year and Swiss Re expect the year-end total to be a market size of $16.4 billion thanks to issuance of $5.8 billion of new risk capital through cat bonds and ILS. This is the second strongest annual issuance and the second largest the market has been at year-end according to Swiss Re’s numbers.
Their numbers show the market has grown by $2.5 billion in 2012, helped by strong issuance resulting in 25 new transactions coming to market. Many of these new deals upsized thanks to the attractive market conditions which were excellent for execution and the increasing interest from capital markets investors. Average cat bond and ILS deal size in 2012 was $224m, significantly higher than the $190m average seen in 2011. 54% of these new issuances have been underwritten by Swiss Re Capital Markets, demonstrating the firms strong position in the cat bond and ILS market. Swiss Re’s numbers include natural catastrophe bonds and mortality transactions. The year-end numbers could change depending on whether transactions complete in 2012 or 2013.
The cat bond and ILS market continues to offer a unique investment opportunity, combining attractive returns with low-correlation to broader financial and economic market fluctuation. Swiss Re has seen more institutional investor capital inflows into the ILS space, helping capacity to increase and the market to grow. Also helping the market to grow is the fact that cat bonds and ILS have become an established alternative to traditional reinsurance and retrocession, offering a real alternative product to insurers and reinsurers. This has helped to keep issuance strong throughout the year and is expected to continue into 2013. Of the 25 new transactions Swiss Re recorded in 2012, you can see details of all of those and three more Swiss Re don’t include in our Deal Directory, there was strong participation in the market from both repeat and new sponsors.
Cat bonds and ILS have once again proved themselves by giving investors an attractive return by proving resilient despite ongoing financial market difficulties. They continue to demonstrate an ability to provide stable returns too, particularly evident this year when other asset classes have experienced volatility. The cat bond and ILS market has yet to experience a negative year, delivering positive returns consistently with low volatility. 2012 will finish the year with an average annual return of close to 9% according to the Swiss Re cat bond indices.
The chart below demonstrates the stable and consistent return profile of catastrophe bonds, as measured by the Swiss Re Global Cat Bond Total Return Index, versus other benchmark asset classes from January 2002 to December 2012.
The chart below shows the lower volatility of the return of the Swiss Re Global Cat Bond Total Return Index, versus other benchmark assets, over a shorter period from January 2011 to December 2012. This lack of volatility is a key factor which continues to make ILS and cat bonds a a very attractive asset class for institutional investors in 2012.
2012 has been an interesting year as far as transaction size, pricing and the spreads achieved on execution of catastrophe bonds and ILS transactions have developed. We’ve seen near record low pricing as we move towards the end of the year, with almost every transaction managing to increase in size and achieve more attractive pricing, something which is sure to make the sector increasingly attractive to sponsors. Swiss Re said they expect spreads will continue to tighten as we move into 2013, but there could again be a chance of a spike if capacity becomes more scarce due to high issuance, as happened at the start of this year. They explained that this is a trend which will likely become less prominent as more capital flows into the market.
Swiss Re went on to discuss how Sandy impacted the cat bond and ILS market. They said that while Sandy was unusual, complex and not a trivial loss event it was not unexpected and northeast U.S. storms and surge events of this size are well within the risk models bounds. The reinsurance markets as a whole, and the catastrophe bond market, reacted in an orderly fashion, both before and after landfall of Sandy.
On the cat bond secondary market reaction, Swiss Re said there was a small amount of speculation prior to Sandy’s landfall, then the market became subdued as it tried to get to grips with the extent of damage and losses, before a few days later some trading picked up again. There was no rush or panic from investors trying to sell positions, which is testament to the increasing maturity of the market and their understanding of loss potential from major events. Secondary market prices of cat bonds are bouncing back, some more exposed cat bonds remain priced 10% to 25% below par but until the uncertainty around industry loss estimates is cleared up they don’t expect any bonds to become really distressed.
Swiss Re said the market reacted to Sandy in a similar way to the Tohoku quake, although in Sandy’s case the potential exposure is much larger given the U.S. wind top-heavy nature of the outstanding cat bond market, with 56.4% of outstanding cat bonds having some northeast U.S. wind exposure. About 20% of the northeast exposed cat bonds saw mark-to-market declines of over 5% within two weeks following the storm. However, the market quickly understood that only a few bonds were exposed and reacted in an orderly fashion. Sandy helps to further underscore the attraction for investors in the diversification possibilities of the cat bond market, and losses will not be meaningful even if the remaining exposed bonds did face losses.
When asked specifically whether they expected any cat bonds to face a loss from Sandy, Swiss Re explained that due to the nature of ILS they cannot comment on specific deals. They said it is still too early to say whether any losses will emerge and that a lot hinges on the development of the PCS loss estimate. Swiss Re’s own Successor Class V – F4 cat bond notes are one such deal which is currently priced down 25% or so in the secondary market, suggesting investors believe it to be one of the most at risk. That deal depends on the PCS loss estimate for its trigger, so until that is finalised we won’t know if it faces a loss. They said that secondary market prices give a good indication of where losses from Sandy are possible (as we’ve discussed before).
Overall, Swiss Re said that they remain optimistic that market conditions for catastrophe bonds and ILS remain favourable, and will continue to do so into 2013. They expect the trend for tightening spreads will continue, which should help to encourage new sponsors to try out the market.
More capital inflows into the ILS, cat bond and convergence sectors of reinsurance are expected, and Swiss Re see’s these instruments playing increasingly important roles as niche product offerings for insurers and reinsurers. They expect the convergence of cat bond and ILS pricing with traditional reinsurance coverage will also continue, which again will encourage new and repeat sponsors to the sector.
They expect demand and supply dynamics will become more stable as capital continues to flow into the space, which should have a stabilising effect on spreads as well and negate the impact that high issuance can have on spreads, as it did early this year.
Finally, Swiss Re said that they expect the cat bond and ILS market will continue to grow in the coming years. With $3.4 billion of outstanding cat bond and ILS deal scheduled to mature in 2013, Swiss Re feels new issuance is likely to exceed it so further growth is clearly within reach.
We will follow up with more insights from the Swiss Re event in the coming days.