With the recent well documented decline in pricing of insurance-linked securities and catastrophe bonds having accelerated into the third-quarter the average multiple at market of catastrophe bonds has dropped to historically low levels, according to data from Lane Financial LLC.
The ‘average multiple at market’ of catastrophe bonds is a metric which denotes the multiple of secondary yields versus the expected loss at issuance of ILS and cat bonds. It’s a metric that Lane Financial, the highly regarded ILS consultancy, has been tracking since 2001 and the metric helps to demonstrate the risk-appetite of investors.
The generally held opinion in the ILS and catastrophe bond market is that multiples of 2.5% to 3.5% are common, depending on the riskiness of a particular cat bond. The average multiple at market has held reasonably steady, at below 4%, since mid-2010 dropping to around 3% when we last discussed it earlier this year in January.
With the recent declines in cat bond yield rates which, according to Lane Financial’s data, accelerated in the third-quarter dropping approximately 16% during Q3 2013 alone, you would expect the average multiple to have declined as well.
In fact, the drop in the average multiple at market has been quite steep. The reason for the steep decline is that as catastrophe bond and ILS rates dropped during Q3, the average expected loss at issuance remained relatively static. This means that the multiple of ILS yield to issuance expected loss dropped significantly.
According to Lane Financial’s data, below, the average multiple at market declined to the historically low-level of 2.2%. This is the lowest that this measurement of catastrophe bond issues has been since Lane Financial began recording it.
Taking this metric into account alongside average expected losses, which did not decline in Q3, it shows that ILS investors are willing to take on more risk for less return, hence the reduction in ILS and cat bond pricing and rates.
Of course the reason for this is the lower cost-of-capital which allows ILS funds and institutional investors to deploy capital for lower return than the traditional market has historically been able to. The way pricing has declined, while expected losses remain relatively static, is clear evidence of the cost-of-capital at play.
How much lower the average multiple could go is hard to predict, of course it does also depend on the level of risk (or expected loss) of cat bonds issued. It will be interesting to see whether this metric of average multiples can go any lower when it is next reported.