The decline in catastrophe bond and insurance-linked security (ILS) spreads and premiums over the last year has been well document, with some tranches seeing 40% declines in pricing over comparable issuance a year earlier.
So it is no surprise that 2013 saw the lowest average capital weighted catastrophe bond spreads (so spreads weighted by size of transaction) at issuance since the cat bond market began in the late 1990’s. However, what might surprise you is that the average for 2013 is actually not that far below levels seen in soft markets of 2003 and 2004.
This chart, taken from a recent report published by Swiss ILS investment manager Plenum Investments, shows the capital weighted spread at issuance for all BB rated catastrophe bonds issued each year. The underlying data is from Guy Carpenter up to December 2011 and then Plenum has added its own data on 2012 and 2013 issuance to bring this chart up to date.
Plenum used this chart in a recent report to demonstrate the development of the premiums of new issues over time. It demonstrates this very clearly and shows the way that the ILS and catastrophe bond market has gone through hard and soft markets over time.
Currently, of course, we’re thought to be in the softest market ever seen in ILS and cat bonds and this chart confirms that, with the average for 2013 coming out at 5.5%. Interestingly, 2012’s figures comes out at 9%, so that is a 39% decline over the last year, very close to the 40% that has often been quoted by people in the market.
At its peak in 206 the average neared 16%, so 2013 was down 66% from the markets hardest point just after hurricane Katrina.
But the really interesting thing to note is that in the soft market of 2003 to 2004, the average was just under 7%, so 2013 saw just about a 20% reduction on that soft market, which given the much greater level of capital and investor interest, as well as increased investor maturity and understanding of the returns required from cat bonds, is actually quite reasonable.
Investors are now much more accepting of catastrophe risk at a lower return, having come to appreciate that their lower cost of capital means they are able to assume risk at lower return levels than they have historically.
It will be interesting to see whether this chart moves much in the years to come and also whether we see such dramatic peaks after large catastrophe events in the future.
It’s worth comparing this with a chart showing the movement in global property catastrophe reinsurance rates on line. The chart below from broker Guy Carpenter, shows its Global Property Catastrophe Rate on Line index from 1990 through to 2014.
If you look at the pattern of rising a falling property catastrophe reinsurance rates since 1998 it tells the same story as the chart on cat bond premiums in terms of where the soft and hard markets are. The two charts move almost in tandem, demonstrating that cat bond spreads reflect pricing conditions in the traditional reinsurance market. Perhaps the same is now true in reverse?