At the end of the fourth-quarter of 2013 the average risk premium of the catastrophe bond market declined once again, with non-U.S. wind exposed cat bond transactions seeing the biggest fall in premiums.
On a quarterly basis we look at two of the key metrics which reflect recent trends in the catastrophe bond issuance market, the average risk premium and average expected loss of the cat bond market. These two metrics demonstrate where insurance-linked securities investors risk appetite lies, when it comes to catastrophe bonds, and how pricing has moved recently.
2013 saw the second highest level of yearly catastrophe bond issuance on record, but perhaps a bigger story has been the way that pricing declined on cat bonds and reinsurance products. The record high level of interest from investors in insurance linked investments, such as catastrophe bonds, ILS funds and sidecars, as well as the low catastrophe losses and well capitalised traditional reinsurance market, helped to drive down cat bond risk premiums to new lows.
Looking at the latest data from Willis Capital Markets & Advisory (WCMA), the capital markets investment banking and advisory arm of global insurance and reinsurance broker Willis, on cat bond risk premiums and expected losses shows that investors appetite for risks and willingness to take on risk for lower returns continued towards the end of 2013.
The WCMA fourth-quarter 2013 ILS and cat bond market report contains its usual two graphs showing the quarterly, last twelve months, weighted average risk premium and expected loss of the catastrophe bond market. Catastrophe bond issuance is split into U.S. wind and non-U.S. wind, with a graph devoted to each grouping.
Both U.S. wind and non-U.S. wind cat bonds have seen the weighted average risk premium decline further through the fourth-quarter of 2013. This again shows that the lower cost-of-capital associated with institutional investor money continues to accept lower returns for catastrophe bond issues. However it is important to look at the two metrics, risk premium and expected losses, together to get a true picture of investor appetite for risk.
Turning to U.S. wind issuance first (see the graphs further down this page), we can see that the weighted average expected loss of U.S. wind cat bond issuance has actually risen since Q3, when it stood at 2.2%, to reach 2.3% at the end of 2013. At the same time the weighted average risk premium of U.S. wind exposed cat bond issuance has declined by a further 0.2%, from 7.4% at the end of Q3 to 7.4% at the end of Q4 2013.
This allows us to calculate the weighted average multiple of U.S. wind cat bond issuance (comparing the risk premium to expected loss), which has declined from a multiple of 3.36x times expected losses at the end of Q3 to a multiple of 3.13x times expected losses by the end of Q4. This shows that investors in U.S. wind cat bonds were willing to take on ever greater amounts of expected loss for lower returns by the end of 2013.
Now looking at non-U.S. wind cat bond issuance, the lower of the two graphs at the foot of this article, we can see that the weighted average expected loss and risk premium both fell sharply in the last quarter of 2013. The weighted average expected loss of non-U.S. wind cat bond issuance fell from 1.4% at the end of Q3 to 0.9% at the end of Q4 2013. The weighted average risk premium of non-U.S. wind cat bond issuance declined from 3.6% to 2.7% over the same period.
Now, it is hard to compare the multiple on non-U.S. wind issuance as there appears to have been a correction in the data used by WCMA, see our article from November and compare the graphs with the ones below, but using the current graph which we’ll have to assume to be correct we can try.
According to the latest graph, the weighted average expected loss was 1.4% and risk premium 3.6% at the end of Q3, giving a multiple of 2.57x times expected losses. At the end of Q4 the multiple had actually risen to 3x times expected losses, which suggests that dealflow towards the end of the year saw investors taking on less risk for a better return in non-U.S. wind cat bonds.
The multiple on non-U.S. wind cat bonds perhaps suggests that catastrophe bond investors are beginning to find a floor in terms of risk premiums, a point which they do not want to drop below. Hence, even though non-U.S. wind cat bond expected losses came down significantly the multiple did not reduce in line with them.
The WCMA data shows that investors were willing to take on more risk for slightly lower returns on U.S. wind catastrophe bonds towards the end of 2013, but on non-U.S. wind investors wouldn’t drop the multiple they received just because the expected loss had declined to almost historic lows (for cat bonds).
It will be interesting to see where these graphs move over the coming quarters as they will give a very strong indication of investor appetite in 2014 and the insurance linked investment market’s appetite for risk. We could see the expected loss on U.S. wind cat bonds rising further, particularly towards the mid-year renewals, if the trend for investors to accept higher tranches of reinsurance program risk continues to develop.
Read our other article on Willis Capital Markets & Advisory’s latest ILS market report: 2014 may be a pivotal year for catastrophe bonds and sidecars.