Cat bonds and casualty sidecars buoyant, but investors still don’t like surprises: Josefs, S&P

At the S&P Global Ratings briefing in Monte Carlo at the RVS, Maren Josefs, Credit Analyst at the company explained that the big stories in insurance-linked securities has been catastrophe bonds and casualty sidecars this year, but she cautioned the market to remember that investors still don’t like surprises.

Josefs explained the ILS market backdrop, “What we’ve seen over the 30-year evolution of the market, more and more voices are now saying that it’s actually part of the strategic risk management for cedents, and that they use it as a supplement to their existing reinsurance programmes and to manage the cycle more efficiently.

“This third-party capital gives citizens greater flexibility and it creates opportunities to seek growth opportunities and manage volatility on their balance sheets.”

How supply meets demand remains critical though and in recent years both sides of that equation have been firing on all cylinders, helping to fuel the growth seen in ILS.

“The third-party capital market is always a question of demand and supply,” Josefs said. “So nat cat losses have been below expectations over the last few years, so investors have also had good performances with double-digit returns in a low correlating asset class, which provides diversification to their overall portfolios, which has driven up supply.

“On the demand side from cedents, we still see the need for risk transfer increasing. As you know, coming back to the changing risk landscapes, we see total insured values going up as a result of inflation and urbanisation. The protection gap between economic and insured losses is still widening across the globe, and at the same time, we have these new risks coming from geopolitics, climate, and technology advances, especially AI.”

Moving on Josefs highlighted the two biggest sources of growth, as catastrophe bonds and reinsurance sidecars. But within the sidecar segment she feels casualty ILS is the bigger story.

Josefs stated, “The two main stories have been the cat bond market and the sidecars, especially on the casualty side.

“On cat bonds, the market is really breaking all records. The good thing about the cat bond market is its transparency, and I think it always gives you a good indication of what’s happening in the market, and it actually confirms what we are seeing on on the traditional reinsurance side as well. The pricing, especially when you look at the multiples… it’s a significant decrease, but it’s not at the level that we’ve seen at the previous soft cycle.”

Josefs noted that spread multiples are not yet down at investors hurdle rates yet though, hence investor appetite remains as cat bond returns remain at or above historical averages at this time.

But she said, “We’re definitely seeing a softening here, also in terms and conditions. A lot more tranches have been placed with higher expected losses. So these are lower down in the in the towers and means that the attachment points are coming down. The average expected loss in 2023 was 1.86 percent according to Artemis, and now we are about 2.85 percent.”

Moving on Josefs explained that, “Sidecars have always been an instrument that cedents have used, but in the last 12 months it’s really been a focus on sidecars in casualty and life. Life is kind of asset-intensive, in which we don’t see our cohort playing a big part. They are really focusing on on the casualty side, and here the growth is really coming from the appetite from investors that are looking to match their longer-dated assets with the liabilities that the cedents have, so it’s a longer term strategy.”

She continued to say, “Property sidecars are normally one to three years, but these casualty side cars are five to seven, up to 10 years,

“There’s a good match between the profiles of the liabilities and the assets. The level in these structures varies across different structures, and it gives a different liquidity and investment profile compared to property sidecars

“But overall, it allows the players to lock in terms and conditions for a longer-time and supports the growth in that area that we have seen as well.

“That said, I think we have to say a warning because these are all new structures. As I said, they’re running five to seven years, they haven’t come to the end, we haven’t seen any losses, and investors don’t like surprises.

“So, we still need to see how that plays out, in terms of when it comes to the end, whether for both parties they work in the way they were intended.”

Finally, later during the S&P Global Ratings briefing in Monte Carlo Josefs discussed the potential for ILS capacity to support data centre risk transfer and premium needs.

“I think ILS can play a role in those big project line sizes. As we said, they normally work very well in supplement with traditional insurance. We’re at very, very early stages, but I know that the market is looking at solutions.

“We have the same problems as we have on the traditional side, in terms of exposure concentration and just understanding the risks properly because they can be coming from different parts of the overall project.

“You’re dealing with energy suppliers, and dealing with construction. So it’s a very complex risk where the market needs some support to really understand the risk, and then hopefully we’ll find some solutions.”