Cat bond coverage to keep expanding, as ILS innovates: GC Securities

Capital market investors continued attraction to relatively uncorrelated property catastrophe risk resulted in further inflows of third-party capital into ILS in 2014. This stimulated further innovation which is expected to continue in 2014, helping cat bond coverage to expand.

In its latest report on the catastrophe bond and insurance-linked securities (ILS) market, GC Securities, the capital markets and ILS unit of reinsurance broker Guy Carpenter, said that it expects to see further innovation in cat bond deals that come to market in 2015.

GC Securities recognised the record year of cat bond issuance seen in 2014, with the firm recording over $8 billion of new issuance and a record market size at year-end as well. The firm said that it expects to see both repeat and new sponsors utilising the catastrophe bond market through 2015, as they seek to take advantage of investor interest.

Investor interest in 2014 drove deal sizes higher, with many of the transactions completing at a larger size than first offered to the market.

Cory Anger, Global Head of ILS Structuring at GC Securities, explained; “Sponsors took advantage of strong investor demand as more than 70 percent of deals coming to market in 2014 settled at greater notional value than initially expected.”

In fact GC Securities recorded four out of the six transactions in the fourth-quarter alone closing at higher notional limits than they were launched at. The average increase in size of these transactions was 44%.

A continued inflow of investor capital also continues to favourably affect pricing for sponsors, enabling many to lock in protection at attractive rates for multi-year terms, which GC Securities terms as a way cedents can “essentially hedge rate volatility.”

GC Securities notes the continued growth of certain factors in the cat bond market, including the indemnity trigger, which continues to prevail, and the growing trend of private catastrophe bond issuance, with 2014 seeing record use of these risk transfer vehicles.

Looking ahead to the rest of 2015, GC Securities expects that continued innovation in cat bond deal terms and structures will help to drive issuance, improving and expanding the coverage available to cedents and sponsors, while also making ILS increasingly comparable to traditional reinsurance.

The market is likely to see more innovative catastrophe bonds issued in 2015, with a particular focus on expanding coverage GC Securities explains.

The firm expects to see the inclusion of more non-modeled risks, such as meteorite impact, wildfire and volcanic eruption in deals that come to market this year. These perils have increasingly been included in cat bonds in recent years and it makes sense that more cedents will look to take advantage of the investor appetite in the market to include at least a small component of risks such as this in their deals.

GC Securities also expects to see the inclusion of more man-made perils (including terrorism) into catastrophe bond structures. This would perhaps be more innovative, as to include these perils would require risk modelling to be done and it would be interesting to see whether property terror risks could be transferred in cat bonds, or whether it would be the mortality associated with it.

The firm expects an increasing number of longer duration cat bonds with terms of greater than five years as sponsors seek to lock-in the very attractive pricing. Again, this makes sense for sponsors in the current environment, however it will be interesting to see whether they achieve this with a direct expansion of term to maturity, or a clever use of staggered aggregate risk periods, such as seen last year in Nakama Re Ltd. (Series 2014-2).

And finally, an increased usage of ILS by corporate sponsors is expected, something that would be welcomed by the market as this could significantly grow issuance in terms of volume and also depth and diversity of risks and structures.

Greater corporate use of cat bonds as a risk transfer structure to offload peak risks has been expected for years, with parametric triggers likely a suitable way to achieve a rapid payout from catastrophe insurance. With appetite for risk so high it would be fascinating to see how a large corporation issuing an earthquake cat bond, for example to protect factories in Japan, would be received by the market.

There is a high chance that the cover afforded by a parametric cat bond could be much greater than traditional property insurance policies might offer, with a much faster parametric trigger payout. But pricing would likely be the key and it’s very difficult to compare the coverage these corporations currently have, if indeed they have any in many cases.

The expansion of the coverage offered by the cat bond market is down to, “The soft rate environment, combined with the presence of “accommodating” investors, allowed cedents to place more innovative, flexible and bespoke transactions,” GC Securities explained.

“We expect repeat and new sponsors to continue to utilize the ILS market in 2015, as they seek to complement their traditional coverage with proven, efficient and bespoke features that can be sourced via cat bond protection,” the report continues.

With the most maturities in the cat bond market ever seen occurring in the first-half of 2015, with already $2.8 billion or more matured in 2015 so far, GC Securities said that this freed up capital is expected to put further pressure on pricing.

Much of this capital is expected to be reinvested into ILS and catastrophe bonds which will help to both drive issuance and keep pricing low, something perhaps evidenced by pricing indications on recent transactions. However continued innovation and expansion of coverage, as GC Securities suggests we will see, should help to ensure that investors appetite for risk and perhaps more importantly diversity continues to be satisfied.

You can access a copy of the full GC Securities Q4 2014 catastrophe bond update via the brokers GCCapitalIdeas website here.