2013 was the most active year ever for issuance of insurance-linked securities (ILS) and catastrophe bonds. After a busy year, with spreads down, the ILS market is expected to broaden its sweet spot in 2014, according to Munich Re.
The Risk Trading Unit of reinsurer Munich Re, , the world’s largest reinsurance firm, has published its fourth-quarter 2013 ILS and catastrophe bond market report today. In its report, the reinsurer looks back at a busy last quarter and year of ILS and cat bond issuance, Artemis recorded 36 transactions in the Deal Directory, discusses some of the trends seen in the market and provides an outlook for ILS in 2014.
The last quarter of 2013 saw a busy period of issuance, with U.S. perils dominating issuance in the quarter. Artemis recorded $1.88 billion of issuance in Q4 which helped to top off the most active year on record in terms of the number of transactions issued.
Munich Re highlights that repeat sponsors USAA, AIG and Argo all chose to leverage cat bond capacity as part of their renewals. Munich Re itself helped to structure Australian insurer QBE’s first cat bond deal, VenTerra Re during the quarter and arranged its subsidiary American Modern Insurance Group’s Queen City Re cat bond as well.
Munich Re counted 33 ILS and cat bond transactions, with an average size of $170m per tranche in 2013, which adds up to $7.5 billion of issuance.
Munich Re said; “As pension funds have allocated substantial capital to this sector over the last two years, strategic sponsors are now able via large-scale transactions to benefit from their long-time efforts to build up and develop this market.”
Some insurers and reinsurers accessed the cat bond and ILS market for the first time in 2013, choosing to make the most of excess liquidity among ILS funds to capitalise on market conditions, said the reinsurer.
Issuance in 2013 far exceeded maturities, Munich Re said that $3.8 billion of new capital inflow during the year has helped to lift the total size of the ILS market in terms of non-life capacity to over $19 billion. U.S. perils continue to dominate this market, with U.S. wind contributing more than 50% of total outstanding capacity, based on contribution to expected loss.
In terms of the declining pricing on catastrophe bonds and ILS, which saw steep declines of as much as 40% between comparable issues from 2012 and 2013, Munich Re said it believes investors will not support further steep declines. The ILS investor base is not ready to support a further decline in risk spreads, said Munich Re, and the investor base does not want to be solely seen as cheaper capacity.
Diversification was in demand in 2013, with the majority of cat bonds being either fully or partially exposed to U.S. perils. This led investors to provide strong support for ILS transactions which did not contain any U.S. perils. There were four such issues in 2013 and all four saw strong investor demand for true diversifying deals helping them achieve very low final pricing of under 300 basis points (3%) for return periods of around 100 years.
Overall pricing in the catastrophe bond and ILS market fell below expectations in 2013, despite the U.S. peril heavy issuance. Most transactions priced at or below the bottom end of pricing expectations, said Munich Re, regardless of what the perils covered included.
The ILS space, like traditional reinsurers, showed some resistance to broadening of coverage or relaxing of terms and conditions, said Munich Re, demonstrated by the inclusion of unmodelled or difficult to model risks which tended to result in some mark-up of pricing.
The steady inflow of new capital into the ILS and catastrophe bond market has allowed sponsors to achieve lower risk spreads on their transactions in 2013. This has enabled sponsors to optimise the multiples on transactions as they have increased the expected loss on the risk issued in ILS and cat bond deals, according to Munich Re. The result is more risk entering the market.
Improved pricing is not just seen in U.S. perils, it applies across all cat bond and ILS issues in 2013. Also the gap between pricing on U.S. perils and non-U.S. perils has narrowed perhaps showing that investors have become more comfortable with assuming more risk from other regions of the world.
Munich Re expects this pricing environment will continue in 2014 and expects sponsors to focus on cat bond transactions in the 2% to 4% expected loss range, a broadening of the sweet spot perhaps allowing more transactions into the market. However, investors remains focused on the higher-layers of risk and demand from dedicated catastrophe funds gets more scarce below the 20 to 25 year return period risks.
The market will accept more risk but it is likely to be a gradual process, with more risk coming in as pricing drops and more unmodelled risks accepted as investors and sponsors become more comfortable with this concept. Despite this, Munich Re expects traditional reinsurance will remain the preferred solution in the working layers of reinsurance programs.
Indemnity triggers are expected to remain a focus of the ILS and cat bond market in 2014, especially as the investor base is increasingly well-equipped to analyse insurance portfolios and the exposure characteristics of cat bond sponsors, said Munich Re. Nonetheless, Munich Re does expect other non-indemnity trigger types will remain key components of the cat bond market, allowing sponsors to tap the capital markets for more exotic risks and for cover which pays out quickly after an event.
Despite the broadening of the ILS markets sweet spot and an increased appetite for risk, Munich Re says that deals with an expected loss of above 3.5% remain an exception in the ILS and cat bond market. Pension funds are now the main investor in the space, both directly and through dedicated funds, and Munich Re expects they will remain focused on the higher return period deals.
Dedicated cat funds with riskier investment mandates and some hedge funds will provide buy-side capacity for lower return period deals, said Munich Re, but this will remain a smaller part of the market.
The full quarterly ILS market report from Munich Re will be available from the reinsurers website.