Signs that the catastrophe bond pricing environment has become more stable are becoming increasingly apparent as the end of 2014 approaches and the pace of price declines continues to slow, according to a report by ratings agency Moody’s.
Using data from the Artemis Deal Directory, Moody’s notes that while the average multiple of catastrophe bonds issued have continued to drop this year, the rate of decline in 2014 has actually moderated somewhat.
When Moody’s published its report, Artemis’ catastrophe bonds and ILS average multiple by year graphic showed an average multiple for 2014 issuance of 2.84. Artemis’ data now has this figure at 2.78 as of December 22nd with the addition of the latest catastrophe bonds to complete. The chart shows that the rate at which multiples declined has slowed.
Last year ended with an average multiple for 2013 catastrophe bond and ILS issuance of 3.14, which at the time was a significant drop from the 4.44 average multiple in 2012, and even more notable from the 5.14 average figure in 2009. While the decline in multiple has continued it has been at a slowing rate, as ILS investors and managers discovered their true cost-of-capital and where the sweet spot for issuance, from a sponsors perspective, sits.
In fact, looking at the Artemis chart showing average coupon and expected loss by year reflects why the multiple decline has slowed. The actual risk level of transactions has been declining (as evidenced by the expected loss) which results in a lower coupon, resulting in a lower multiple. Pure year-on-year pricing decline is therefore only part of the story, as far as changing multiples are concerned.
The report, which was produced by Moody’s Global Insurance Group Vice President and Senior Analyst David Masters, states; “This slowdown also reflects the increasingly tough stance that investors have taken in recent months regarding the minimum price demanded for new cat bond issuances.”
Moody’s agrees with our opinion that investors are applying some pressure to force a floor in cat bond pricing, as evidenced by recent deals many of which have priced at or even above the mid-range of initial guidance. While a few transactions have continued to price down, these tend to have something unique about them or have a clear reason why investors may value the notes enough to come down further on pricing. For the more commoditised risks and perils the pricing floor appears to be emerging or perhaps already be established.
Moody’s believes that the slowing down in the decline of the multiple does provide a signal that the “market bottom is beginning to emerge.” The rating agency also mentions the fact that in the last quarter pricing finished roughly flat across cat bonds as an average, while in December the bonds offered actually priced very slightly above the mid-point of guidance on average.
“Unsurprisingly, this apparent bottoming out of cat bond prices coincides with a gradual uptick in risk-free rates during 2014 year-to-date. Whilst it is too early to call a true bottom to the cat bond market, this emerging trend supports our view that cat reinsurance rates will decline by (only) around 10% in 2015, a relative improvement vs. 2014,” Moody’s explains.
Of course while catastrophe bond rates have been declining, the return to investors has as well. 2014’s cat bond issuance has an average coupon of just 4.56%, which is down around 26% from the average 6.18% available on 2013 issuance. At the same time the average expected loss of 2014 issuance is 1.64%, down 17% from the 1.97% average expected loss from 2013.
That shows that while coupons have declined 26% year-on-year, so has the level of risk issued, according to the expected losses of 2014 issuance. So while coupon declines have outpaced expected losses, the per-unit of risk assumed return to investors decline is not as steep as it first looks.
And demand remains high. 2014 is set to become a record year for catastrophe bond issuance, as of today Artemis has recorded $8.794 billion of new cat bond and ILS issues brought to market, with the addition of Amlin AG’s Tramline Re II Ltd. (Series 2014-1) cat bond and the private deals facilitated by Hannover Re (Leine Re and LI Re 2014-2) now completed.
So it’s apparent that despite the lower current pricing and the dip in multiples, catastrophe bonds remain an attractive way of diversifying sources of reinsurance risk capital for sponsors and as low-correlated investments for third-party investors. Further evidence is seen in the asset classes continued expansion into new regions and perils, a slow but steady driver of continued market growth.
Moody’s picks up on this point as a driver of future growth for ILS; “As European and Asian/Oceanic natural catastrophe models become more sophisticated, it is likely that investor appetite for such cat bonds will increase. Equally, “non natural catastrophe” bonds are starting to emerge which, which will spur further demand for this asset class.”
Other factors driving continued growth for catastrophe bonds and ILS are, according to Moody’s, the expectation that interest rates will remain lower for longer and the fact that the global asset management industry still only deploys a miniscule amount of its overall capital into reinsurance and ILS. That leaves plenty of scope for continued growth of the ILS asset class as we move into 2015.