Cat bond market’s merit underscored. Rate hardening expected: Swiss Re

The catastrophe bond market’s merit was underscored by the way it continued to operate effectively despite recent volatility stimulated by catastrophe losses, but after the losses it is expected that investors will want to see cat bond rates harden, according to Swiss Re.

The global reinsurance firm has published its latest review of the catastrophe bond and insurance-linked securities (ILS) market, analysing issuance through the final months of 2018.

Swiss Re highlights the challenges faced by cat bond investors and cat bond investment fund managers through 2018, both due to fresh losses occurring during the year as well as the hangover left behind by 2017 loss events.

But the Capital Markets team of reinsurance firm Swiss Re explains that the cat bond market performed admirably under stress, with the asset class demonstrating its value as a liquid ILS asset with secondary transferability.

In particular Swiss Re highlights the challenging second-half of the year in 2018, citing the “negative loss developments from Hurricane Irma and a barrage of nat-cat events once again challenged the market norms of previously benign catastrophe years.”

Cat bond investors had “remained steadfast” in holding their cat bond positions through the first-half of 2018, despite exposure to still creeping and developing potential catastrophe losses, Swiss Re explains.

But cat bond market volatility spiked in the second-half of the year, as fresh hurricanes (Michael and Florence) as well as the California wildfires resulted in exposure developing for numerous cat bonds, the reinsurance firm said.

With some ILS funds facing redemptions and trapped capital within collateralized reinsurance transactions they had entered into, at the end of 2018, the catastrophe bond market had another chance to prove its merit.

One of the features of the catastrophe bond that is often overlooked is the readiness with which it can be sold or transferred to another party.

The ability to trade cat bonds significantly benefitted these ILS funds that were dealing with trapped capital and redemptions, enabling them to free up capital by offloading their cat bonds through the secondary market.

Swiss Re notes that these funds looking to sell were met by a “willing secondary market” and trading activity was particularly high, demonstrating the importance of at least one type of ILS asset having secondary liquidity as we have explained before.

In addition, this sell off allowed other investors to “scoop up bonds at increasingly attractive prices” the reinsurance firm explained.

Overall, this period of volatility actually helped the cat bond market to demonstrate precisely why it is so valued by many in ILS investing.

This second-half of 2018 activity, “Underscored the cat-bond market’s merit by providing consistent liquidity while also demonstrating that committed investors still find value in this diversifying asset class,” Swiss Re said.

But after such a volatile period that included some losses for cat bond funds and investors, Swiss Re expects that the ILS and cat bond market is definitely ready to harden somewhat.

“After experiencing 18 months of above average industry losses, we expect that investors will likely want to see rates harden in 2019, especially for loss-impacted tranches,” Swiss Re forecasts.

Continuing, “We expect this will be the case particularly for aggregate transactions and those structures exposed to perils with less robust catastrophe models.”

There is already some evidence of the market for catastrophe bonds hardening, with all three of the main 144A catastrophe bond transactions issued so far in 2019 having seen their coupon prices settle at the top-end of initial guidance.

That bodes well for a better level of return in the catastrophe bond market through 2019 issues, however it will be interesting to see how the mid-year renewal deals are priced in the weeks to come. The loss affected cat bond renewals and those focused on regions where losses have been suffered are likely to see increases it seems.

It will be interesting to see whether other peril regions and sponsors do as well. Early indications from the first three 144A catastrophe bonds, Atmos Re DAC, Baltic PCC Limited (Series 2019) and Cape Lookout Re Ltd. (Series 2019-1), suggest this could be the case.

But despite this expectation of a market ready to harden (somewhat) Swiss Re believes that the catastrophe bond will retain its allure for sponsors, saying, “We believe the ILS value proposition still rings true as a diversifying and complementary capacity source.”

If the cat bond market can maintain the slight hardening already seen in recent deals, it’s certain the value proposition for cat bond investors will persist as well.