Swiss Re Insurance-Linked Fund Management

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Catastrophe bond market reaches all-time high with 20% growth: Swiss Re


Global reinsurance firm Swiss Re says that 2013 will be the second strongest for catastrophe bond and insurance-linked securities (ILS) issuance on record, helping the outstanding cat bond market grow by 20% this year to reach an all-time high.

Swiss Re executives at a media event held this morning said that 2013 will not see record levels of issuance, rather it will be the second highest level of cat bond and ILS issuance on record. Earlier this year it looked as if 2013 would beat the record level of issuance seen in 2007, but the bumper Q4 cat bond pipeline has not materialised meaning 2013 is set to become the second strongest year in the markets history.

Martin Bisping, Head of Non-Life Risk Transfer at Swiss Re, said that the market should reach $20 billion of cat bond and ILS risk capital outstanding by the end of the year. With 26 transactions completed year to date, with two additional cat bonds still being marketed, Bisping said the market will end the year at an all-time high.

In terms of outright growth, the cat bond and ILS market will end the year approximately 20% bigger than it began it. The amount of cat bond risk capital outstanding at the end of 2012 was $16.6 billion. Currently Swiss Re puts that number at $19.6 billion and with the addition of the two deals which are still to complete, Residential Re 2013-2 and Tradewynd Re 2013-2, Bisping said the market will get close to $20 billion.

Catastrophe bond issuance and outstanding (USD bn)

Catastrophe bond issuance and outstanding (USD bn) - Source: Swiss Re

Since 2011 the outstanding catastrophe bond market has grown by around $6 billion, approximately 43%, helped by both repeat and new sponsors coming to market and relying on cat bonds as part of their risk transfer programs. Repeat sponsors have largely driven this growth, with large global insurance companies taking advantage of low cat bond spreads and structural innovations. However, Swiss Re estimates that $2 billion of the growth seen since 2011 comes from new sponsors.

Investor demand is a significant factor in the cat bond markets growth, said Bisping, with demand from capital markets investors continuing to outstrip supply of new risk capital in ILS form. The low correlation of the ILS and cat bond asset classes remains a major draw for investors such as pension funds.

Bisping went on to discuss the pricing patterns seen in the catastrophe bond market in 2013. Year-on-year spreads for U.S. wind exposed cat bonds are down around 40%, while at the same time non-U.S. wind cat bonds have seen spreads decline by 35%. This trend has helped to attract new sponsors to the market and helped encourage repeat issuances.

Illustrative primary issuance spread (US Wind cat bonds)

Illustrative primary issuance spread (US Wind cat bonds) - Note: Swiss Re Capital Markets pricing indications only; estimated primary issuance spread computed for an expected loss of 2% using regression analysis

The graph above shows how U.S. wind cat bond spreads have changed over the last twelve years. It’s clear that U.S. wind spreads are now at an all-time low. The question has to be how a chart like this will react after the next major event or during the next hardening market and whether the growth of alternative reinsurance capital will mean we never see the peaks again.

Bisping highlighted that 2013 saw a new low in terms of pricing for non-U.S. wind cat bonds, with some breaching the 300bps (3%) spread level for the first time. While U.S. wind continues to dominate the market, accounting for roughly 65% of 2013 issuance, demand for diversifiers remains strong and this helps non-U.S. wind risk price at tighter levels as investors seek out diversifying perils.

The chart below shows 2013 spread levels versus expected losses. You can clearly see that non-U.S. wind perils are pricing significantly lower than their equivalent U.S. wind transactions. It is the historic low pricing across all perils which has helped to increase sponsors interest over the course of the year, explained Bisping.

2013 catastrophe bond primary issuance spread

2013 catastrophe bond primary issuance spread - Source: Swiss Re

Bisping reiterated Swiss Re’s opinion, which we wrote about previously here, that cat bond spreads and pricing may have reached, or is approaching, a natural baseline. He said that high yields are much of the attraction to the asset class for investors and that some have hinted they would slow down commitments to the market if pricing drops much further.

Bisping said that spreads for top layers of risk have been relatively stable for some months now, although some lower layers of risk in cat bond form could see further room for pricing to drop. Bisping shared an updated copy of the chart we wrote about a few months ago, showing cat bond secondary spreads having levelled off significantly.

Catastrophe bond secondary market spreads

Catastrophe bond secondary market spreads - Source: Swiss Re

Bisping moved on to the investor landscape, explaining that pension funds are increasingly interested in catastrophe bonds and reinsurance as an asset class. Much of this capital is coming into the market through dedicated ILS fund managers, while some mutual funds and institutional money managers are also increasingly allocating to the asset class.

Conversely, interest in cat bonds from short-term oriented hedge fund managers has been on the decrease, with their share of the market dropping. While the investor base in cat bonds has definitely broadened, Bisping said, the asset class remains dominated by dedicated cat bond fund managers.

Bisping then shared a breakdown of the types of investors in the market in 2013:

Typical catastrophe bond investor breakdown by type 2013

Typical catastrophe bond investor breakdown by type 2013 - Source: Swiss Re

Investors are getting increasingly more comfortable with more complex transactions as well, explained Bisping, with indemnity triggers making up 50% of cat bonds issued in 2013. Industry loss index remains the second most widely used trigger, with parametric and others bringing up the rear and their usage potentially shrinking in 2013.

Catastrophe bond trigger breakdown (2009 - 2013)

Catastrophe bond trigger breakdown (2009 - 2013) - Source: Swiss Re

Another sign that investors are becoming more sophisticated and accepting of complex catastrophe bond deals, is the recent transaction which has seen cat bonds being used much lower down the reinsurance tower in the working layers of a major program. here Bisping is referring to the Residential Re 2013-2 deal with its riskier tranche having an expected loss of over 10%. The successful issuance of this deal could lead more sponsors to seek to emulate it, opening up a new section of the risk tower to cat bond investors.

Bisping summed up on cat bonds by saying that he expects the low-interest rate environment and financial market uncertainty will help to keep investor interest in cat bonds high. Continued capital inflows will keep demand high and spreads down, making cat bonds an attractive option for sponsors.

While cat bonds will continue to gain some market share of property catastrophe risks, Bisping said he expects them to remain a complementary product as reinsurance alternatives remain efficient.

Looking ahead to 2014, Bisping said he expects the active catastrophe bond issuance environment to continue and that indemnity triggers will remain attractive as sponsoring insurers look to eliminate basis risk while taking advantage of the continued low spread environment. Low spreads, said Bisping, will continue to be the main driver of strong issuance.

So while the cat bond market will reach some highs by the end of 2013, it now seems certain that we will not see record issuance. We’re now too near to the end of the year for sufficient cat bond deals to launch and complete by year-end. With quite a number of cat bonds maturing at the end of the year we may see a bumper first-quarter of 2014 cat bond issuance, although market sources do suggest that a number will not be renewed due to attractive pricing of collateralized and traditional reinsurance alternatives.

Nevertheless, 2013 has been an extremely strong year for the catastrophe bond market and the really important number to watch is the markets outright growth. With a near 20% increase in cat bond risk capital likely by year-end, almost 42% since 2011, the catastrophe bond market has been growing at a quicker pace than the global reinsurance market as it continues to take market share of the layers where it is most appropriate.

Don’t forget you can read about every catastrophe bond transaction issued in our Catastrophe Bond & ILS Deal Directory.

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