Alternative capital, ILS take 20% of catastrophe reinsurance market: Aon Benfield

Alternative reinsurance capital, made up of insurance-linked securities (ILS), catastrophe bonds, collateralized reinsurance, sidecars and ILW’s etc, has captured 20% of the property catastrophe reinsurance market, according to Aon Benfield.

The stunning figure, which clearly underscores the growth of the capital markets and its full-on convergence with traditional reinsurance coverage, is for an annual period of review from Aon Benfield’s latest ILS market report.

In the 12 months running to 30th June 2014, Aon Benfield counted $9.4 billion of catastrophe bond issuance, a little behind the $10 billion record Artemis covered, which the reinsurance broker says is a 41% increase over the previous year.

Add to the high volume of cat bond issuance 11 collateralized reinsurance sidecar transaction totaling $1.4 billion and other collateralized reinsurance vehicles and the total allowed alternative capital to capture around a 20% market share of the property catastrophe reinsurance market during the year.

Growth of alternative reinsurance capital solutions in property catastrophe reinsurance market - Source: Aon Benfield

Catastrophe bonds and collateralized reinsurance has driven this growth and penetration deeper into the property catastrophe reinsurance market, notes Aon Benfield. The growth of collateralized reinsurance has also demonstrated investors appetite for access to risks and returns not currently available in the catastrophe bond market, the broker says.

The report notes a number of records during the annual period under review, including record second-quarter cat bond issuance of $4.5bn across 12 transactions and record first-half issuance of $5.9 billion, which exceeds the prior year period by almost 50% (1H 2013 – $4.0 billion).

By Aon Benfield’s reckoning, the outstanding catastrophe bond market reached a record $22.4 billion of cat bonds on-risk, which equates to growth of $4.6 billion in just one year. This is slightly below the record of just over $23 billion recorded by Artemis, due to our coverage of more private transactions than Aon’s report.

In the annual period reviewed, Aon Benfield recorded 24 new catastrophe bonds issues covering U.S. perils, five with European exposures. Also, four catastrophe bonds covering Japanese perils were issued in the year, compared to none in the prior year, which Aon Benfield says demonstrates the strong and increased interest in the use of the capital markets from Japanese sponsors. Details of every catastrophe bond transaction can be found in our Deal Directory.

Seventy percent of the property catastrophe bonds issued utilised indemnity triggers covering regions of the world as diverse as Australia, Europe, Japan and North America.

Aon Benfield estimates that between $5 billion and $6 billion of new capital flowed into the ILS sector during the year, which it believes takes the total capital inflows of the last two years to over $10 billion.

At the same time and partly stimulated by the rapid inflow of capital, ILS market pricing conditions for continued to decline to reach historically low levels. This allowed sponsors to benefit from price reductions of 20% or higher, as investor demand kept pace with the increased ILS supply, ultimately seeing sponsors expand their ILS coverage at competitive rates.

Paul Schultz, Chief Executive Officer of Aon Benfield Securities, commented on the record year; “The 12-month period under review was one of the strongest ever for the ILS and wider alternative capital markets. Sponsors received improved terms including increases in catastrophe bond maturity periods and a continued decrease in interest spreads to historical lows. Improvements in both pricing and terms and conditions also brought a record number of new sponsors to the market.”

As ILS and catastrophe bonds increasingly seek to match the cover provided by traditional reinsurance issuance has picked up as a result. However, the record low pricing has been a key driver of issuance in the last year.

Paul Schultz explained; “The average duration of catastrophe bonds has increased steadily over the past three semi-annual issuance periods, but the main driver in the market expansion is the large amount of new issuance driven by highly favourable pricing conditions.”

Another driver of issuance is the continued low interest rates in wider financial markets, which attract investors to reinsurance and ILS more readily.

“In the 12-month period under review, interest spreads reached historic lows. This encouraged even more sponsors to consider ILS solutions as part of their risk transfer strategies—a record 13 new sponsors secured coverage during this time,” Schultz said.

Aon Benfield’s ILS and catastrophe bond indices, which track the performance of various baskets of cat bonds, all posted gains for the year. The Aon Benfield All Bond and BB-rated Bond Indices returned 7.74% and 4.99%, respectively. The U.S. Hurricane and U.S. Earthquake Bond Indices returned 8.94% and 4.33%, respectively.

The Aon Benfield ILS Indices outperformed most of the comparable fixed income benchmarks, however the 3-5 Year BB High Yield Index and the S&P 500 index produced superior returns during the year under review, a reflection of the lower ILS pricing and as a result yields in the last year.

Looking ahead Aon Benfield, the leading intermediary and facilitator of cat bond and ILS transactions as our leaderboard shows, expects the strong performance from ILS and the cat bond market to continue.

“In all, the catastrophe bond market has seen $60.1 billion of cumulative issuance since 1996, demonstrating its importance as a strategic and efficient risk management tool. The growth of the market has accelerated in the 12 months under review, and we expect the strong performance to continue for the remainder of 2014 and beyond,” Schultz forecast.

Aon Benfield predicts $8 billion of catastrophe bond issuance for 2014 and believes the market is on track to achieve this. Helping the market achieve this level of activity is the increasing usage by both repeat and new sponsors of the capital markets, as a source of reinsurance capacity, and the ever-growing investor appetite for ILS and reinsurance as an asset class.