Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Cat bond yield expectations rise on back of mark-to-market losses


Catastrophe bond fund managers have adjusted upwards their expectations of yields for their cat bond funds, both in terms of the anticipated yield to maturity and the future yields as they begin to communicate an expectation of a hard(er) reinsurance market going forwards.

Reinsurance rate rises possible in 2018Following the impacts of hurricanes Harvey, Irma, Maria and earthquakes in Mexico, on top of some aggregate deductible erosion earlier this year from severe thunderstorms, a number of catastrophe bonds face losses and more are at-risk of triggering.

This has caused a downshift in pricing in the secondary market, as pricing sheets reflect the already clear losses ( and ) as well as the expectation or chance of losses manifesting once the sponsors losses are better understood.

According to consultancy Lane Financial LLC, following the hurricanes the yields in the catastrophe bond market are up between 15% and 25%, a number it cautions could “easily rise that much again” as the real impacts of the hurricane season become clearer.

Additionally, the mark-to-market loss on secondary bonds reflects not just an expectation of losses,  but also “the view that the next issue of similar bonds will be issued at higher yield,” Lane Financial explains.

As a result catastrophe bond fund managers have been communicating to their investors that they now expect a significant uplift in yield to maturity of the current vintage of catastrophe bonds, and better returns for cat bonds in which they invest in the future.

Catastrophe bond funds will all report negative returns for September, it’s hard to foresee any not doing so given the decline in the broader cat bond market value. As far as we can tell, the decline for cat bond funds we’ve seen returns for ranges from -3% to -8%, with a decent spread along that spectrum of returns.

The Swiss Re cat bond total return index recorded a drop of -6.57% in September, while another pricing source saw the market dropping by just over -5%.

As a result, the majority of catastrophe bond funds are likely to report returns in a range from -4% to -6% for September, but due to the decline in secondary values a jump in their expected yields to maturity.

One cat bond fund, the SEF Entropics Cat Bond Fund managed by Swedish ILS fund manager Entropics Asset Management AB, reported that its yield to maturity has almost doubled, from 4.84% to 8.42%, which it sees as a mix of secondary market price decline and an expectation of future premium increases.

Robert Lindblom, CEO of Entropics, explained; “The increased yield to maturity can be attributed partly to bonds expected to trigger and priced below par – but still paying full coupon, and the prospect of a higher future yield. Approximately 40% of the yield to maturity increase in the past month can be said to reflect the market’s demand for higher risk adjusted returns. ”

Lindblom said that cat bond funds September performance decline is not only a reflection of expected losses for the market, but also of the markets anticipation of premium increases.

“In a sense, this year can be described as a turning point in the very soft reinsurance market we have faced over the past years. This will serve to strengthen the investment case of cat bonds for investors,” he continued.

Just how hard the market turns out to be may also be at the whim of catastrophe bond investors, to a degree.

How much compensation investors demand for future pipeline cat bond deals will have a significant bearing on the ability of the broader reinsurance market to sustain any price rises that are pushed through in January to future renewals.

A hard market could therefore be relatively short-lived, in terms of increasing prices. However we’re beginning to hear from sources who suggest that the next pricing floor may be installed a few notches higher than the last, due to the size of losses from recent catastrophe events.

Some markets are said to have realised that catastrophe risk pricing had dropped too far, in certain cases, while at the same time they were not pricing sufficiently for the expanded terms cedents and sponsors were benefitting from. This is post-soft market reflection at its best.

That could force the floor a little higher, at least until the next wave of capital flows in.

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