Net capital inflow into insurance-linked securities (ILS) hit $3.1 billion in Q2 2014, as the brisk issuance and the largest single catastrophe bond issuance in the market’s history pushed outstanding cat bond capacity to a record high, said reinsurer Munich Re.
The world’s largest reinsurance firm Munich Re’s Risk Trading unit has published its latest quarterly ILS and catastrophe bond market report today. The Q2 ILS market report looks at issuance and trends in the second-quarter of 2014. Once again it’s worth noting that Munich Re’s numbers do not include private transactions or cat bond lite deals, so differ slightly to the numbers in the Artemis Deal Directory.
Munich Re recorded $4.5 billion of new catastrophe bond issuance in Q2 from 12 transactions, a little under the $4.634 billion Artemis recorded. With maturities during the quarter only amounting to $1.4 billion Munich Re says that the ILS market saw net new capital inflow of $3.1 billion in Q2 taking the outstanding catastrophe bond market to the highest level ever recorded, at $21.7 billion.
Q2 2014 was dominated by U.S. sponsors of catastrophe bonds, as is the norm for the quarter prior to the start of the Atlantic hurricane season. Both Allstate (Sanders Re Ltd. (Series 2014-1) & Sanders Re Ltd. (Series 2014-2)) and USAA (Residential Reinsurance 2014 Ltd. (Series 2014-1)) showed their strategic position on utilising the capital markets for reinsurance, with issuances from both of the large primary insurers. Newcomers also showed a desire to tap the cat bond market as well, notes Munich Re, highlighting Heritage (Citrus Re Ltd. (Series 2014-1) & Citrus Re Ltd. (Series 2014-2)), Everest Re (Kilimanjaro Re Ltd. (Series 2014-1)) and TWIA (Alamo Re Ltd. (Series 2014-1)).
Topping the quarters issuance was the record $1.5 billion catastrophe bond from Florida Citizens, Everglades Re Ltd. (Series 2014-1), without which the quarter would not have been a record, Munich Re highlights. This deal took the quarterly issuance to a record level surpassing the high level of Q2 cat bond issuance seen a year earlier.
Other deals of note in the quarter featured Munich Re as a co-structuring agent. Insurer Generali’s first cat bond issuance, Lion I Re Ltd., was co-structured by Munich Re and secured the first competitively priced indemnity-based European windstorm cover, according to the reinsurer. The other deal of note was the World Bank’s first direct catastrophe bond issuance for the Caribbean Catastrophe Risk Insurance Facility, World Bank – CCRIF 2014-1, which Munich Re also co-structured.
Due to the high levels of issuance and strong capital inflows pricing has been steadily on the decline in recent quarters, notes Munich Re. However with issuance exceeding maturities by $3.1 billion in Q2 some strain has been placed on ILS capacity.
Rising yields in the secondary market show that the return requirements of ILS investors have reached a floor in recent weeks, says Munich Re. As a result of this, Munich Re said that it pulled the issuance of its Queen Street X Re transaction, saying that it could not meet its pricing targets for the capacity it was seeking at the end of the second quarter.
Interestingly, Munich Re says that it expects growth in the ILS market to dwindle over the coming months. In the last few years pension funds in particular have been attracted to ILS by the high returns achieved by ILS managers and catastrophe funds, says the reinsurer, but these have been largely driven by higher yielding cat bonds issued prior to 2012.
From 2012 on the yields on catastrophe bonds have been on the decline, leading to lower returns for ILS funds and also prompting ILS fund managers to increasingly allocate capital to collateralized reinsurance in search of higher returns. But for pension funds and traditional asset managers, the more public cat bond market is often a preferable investment over the less liquid private transactions, explains Munich Re.
As a result Munich Re expects investors to limit some of their future allocations to ILS so growth may be slower. In particular, Munich Re expects prices to harden to a degree for U.S. exposed hurricane and earthquake cat bonds as the market is so exposed to these perils. Munich Re notes that risk spreads have actually widened in 2014 year to date, where diversifying perils have tightened, in the secondary market.
Capital inflows have slowed towards the end of Q2 as ILS managers realised that capital was outweighing opportunities. However during the quarter many managers continued to attract new mandates from pension funds, despite the increased focus on collateralized reinsurance and private deals.
In fact, in our experience, pension fund managers are not as concerned about liquidity and the issue of private deals as you might believe, with many of them looking to ILS and catastrophe risks as an alternative asset class, rather than a fixed income replacement. Many alternative asset classes are relatively illiquid, so the illiquidity in private ILS may prove to be less of an issue than some believe.
Time will tell in terms of ILS market growth, however a period of slower growth is likely after the rapid expansion seen in the last year. Munich Re’s point that U.S. ILS prices may harden as investors demand a premium for a peril which the market is overexposed to is interesting and it will be fascinating to watch how pricing develops later this year once the pipeline for these perils opens up again.
Despite an expectation that capital inflows may stagnate, Munich Re notes that the investor base in ILS has grown and become more accepting of a greater range of structural features within ILS and cat bond transactions. This has resulted in a move away from standardised, synthetic covers to more customised indemnity based solutions, as well as sponsors testing the market with a range of unmodelled risks.
The reset for ILS and cat bond deals have now become predominantly structured using variable terms, allowing sponsors to flex the coverage their cat bonds provide. In the second quarter of 2014 the variable reset has become the dominant reset structure for catastrophe bond issues and Munich Re expects this to continue as sponsors look to more closely match ILS cover to their reinsurance needs and the cat bond market is expected to increasingly shift towards more sponsor friendly structures.
Munich Re’s report contains a closer look at the use of the variable reset, as well as other charts and data points on the ILS and cat bond market. You will be able to access a copy of the report via the reinsurers website here (available soon).
Artemis’ Q2 2014 Catastrophe Bond & ILS Market Report – The Biggest Quarter, The Biggest Catastrophe Bond
We’ve now published our Q2 2014 catastrophe bond & ILS market report.
This report reviews the catastrophe bond and insurance-linked securities (ILS) market at the end of the record second-quarter of 2014, looking at the new risk capital issued and the composition of the transactions completed during Q1 2014.