ILS and cat bond investor discipline helps market stabilise: Swiss Re

Investors in the insurance-linked securities (ILS) and catastrophe bond space continue to show discipline on terms and conditions (T&C), new transactional features and pricing so far in 2015, according to reinsurance giant Swiss Re.

Competition in the global reinsurance, ILS and cat bond market continues to impact primary and secondary market spreads, as investor demand for higher risk, higher yielding securities remained evident during the first-half of 2015.

Reinsurer Swiss Re notes that primary cat bond spreads appear to have stopped compressing as 2015 moves past the half-year mark, signalling that perhaps the sector might have reached a pricing floor and that investors are showing increasing market discipline.

When compared to similarly rated corporate High Yield (HY) bonds, the spread between these and cat bonds during January 2015 was the tightest it’s been since the wave of alternative insurance and reinsurance capital entered the ILS market.

However, since the turn of the year Corporate HY spreads have begun to tighten back advises Swiss Re, while the cat bond market has seen spreads resist tightening, and even begin to widen in some cases.

Comparing catastrophe bond and high-yield bond spreads - Source: Swiss Re

“Meanwhile, in the cat bond market, we’ve noticed that spreads have ceased to tighten, demonstrating that the market may have achieved a floor.

“Spreads in both the primary and secondary markets maintained their relative stability and in some cases began to widen from the lows experienced over the summer one year ago,” said Swiss Re.

Furthermore, Swiss Re Capital Market’s ‘July 2015 Insurance Linked Securities market update’ report highlights a divergence trend in the secondary cat bond market, as the more risk remote cat bond layers show signs of widening, albeit slight, while unrated, higher risk layers continue to see spreads tighten.

This isn’t too surprising, as market participants continue to search for ways to navigate and offset the challenging re/insurance market environment by seeking a higher returning security.

Showing that investor appetite for a higher yielding note remains strong, resulting in intense competition for the riskier layers of protection and thus reducing the overall availability of these risk layers.

Demand for the more risk remote BB- and B- rated cat bond layers is still apparent, as evidenced in the Swiss Re report, as investors still need to achieve a certain level of return, but compared with the riskier layers of protection demand is less apparent, resulting in the widening of spreads noted by Swiss Re.

Secondary cat bond spread development - Source: Swiss Re

Moving away from ILS and cat bond spreads, Swiss Re underlined increased discipline from investors surrounding the host of new innovative features and structures introduced by sponsors during the first-half of 2015.

Sponsors, investors, insurers, reinsurers and capital markets participants, including industry experts and analysts, have noted and discussed the structural shift in the market environment in recent months.

And as a means of hedging the lack of returns available in the property catastrophe reinsurance space, due to excess capacity and heightened competition, and increasingly in primary lines also, a relaxation of certain T&C and the introduction of new structures began to impact the sector, “as sponsors try to develop the market to more efficiently meet their hedging needs.”

“However, investors have drawn a line in the sand and have been vocal that such adjustments to structure shouldn’t be punitive to them and should be properly priced into the transactions,” advised Swiss Re.

Continuing to add; “Investors have particularly pushed back on changes to term, variable reset mechanics and day-count fractions, though they’ve stressed that they’d be willing to accept these changes as long as they were appropriately compensated for them.”

It’s promising to hear that investors in the space are pushing back against T&C relaxations, a trend that saw deals hours clauses extended among other changes in recent times, as sponsors tried to secure the desired level of capital at a reasonable price for transactions.

However, as noted by Swiss Re, should the price be right it seems investors would be willing to take on a little more risk through the use of new, untested and innovative structures, and changes to T&C.

For the remainder of the year and into 2016 Swiss Re notes, “For the first time in a long time the cat bond market is poised for mild increases.

“It appears that the downtrend has eased and we wouldn’t expect rates to achieve new lows, year-over-year, going forward the next few quarters.”