Catastrophe bonds became more important for the reinsurance market in 2020, as the record year of issuance saw use of the cat bond as a reinsurance or retrocession risk transfer tool increase, Fitch Ratings has said.
While alternative capital levels remained relatively flat overall through 2020 it seems, the catastrophe bond market was one area that gained during the year.
Catastrophe bonds gained in importance at the expense of collateralised reinsurance programmes, Fitch Ratings said in a recent report, highlighting a bit of a shift in investor demand for ILS products that was one of the drivers.
“Investors changed their preferences as catastrophe bonds in comparison offered a higher liquidity and a more clear-cut definition of what perils are covered,” the rating agency explained.
The strong availability of risk capital to support catastrophe bond issuances also helped to reduce the upward pressure on pricing in the retro market, Fitch believes.
We’d add a number of other factors that have either helped to make catastrophe bonds increasingly important for the reinsurance market through 2020, or demonstrated that importance.
Catastrophe bonds had come through the recent catastrophe years with relatively few losses, compared to some collateralized reinsurance or retrocession strategies, which means some cat bond funds have seen less impact to their track records and this has helped to sustain investor allocations and interest.
In addition, as well as favouring the relatively clear-cut nature of many cat bond triggers, as Fitch explains, plus the secondary liquidity options available in that market, the cat bond is also a fully securitized asset with the market as a whole offering a relatively low to mid-risk entry point to insurance-linked returns.
This, combined with track records that haven’t been so dented, has helped both in gaining new allocations from existing investors and attract new investors as well.
Of course, the catastrophe bond market has also benefited from the increases seen in reinsurance and retro rates as well, so in some cases cat bonds now can even offer a better risk adjusted return.
In fact, the potential returns of the cat bond market could be back at levels not seen since 2012/13.
All the while the ceding companies, so insurers and reinsurers, have continued to look favourably at the structure, execution and pricing of new catastrophe bond issues, meaning ample interest in cat bonds as a risk transfer product as well.
Of course, investor interest is also high, as globally institutional investors continue to look for relatively uncorrelated and diversifying asset classes that can deliver returns over the longer-term horizon, which the cat bond track record would suggest this market can.
So there are many factors that have helped to underscore the important role catastrophe bonds play in the reinsurance market in the last year and we expect these factors to continue playing a perhaps increasingly important role going forwards.
The rating agency said, “Fitch expects that alternative capital in general – and catastrophe bonds in particular – will maintain their role for the reinsurance market in 2021.”
If a number of stars align and the use-case for the catastrophe bond can also continue to expand to bring in new sponsors, not least corporate, sovereign and state entity sponsors, then the future looks bright for cat bonds gaining even more importance, not just in reinsurance but in provision of insurance capacity as well.
For full details of cat bond and related ILS issuance, including a breakdown of deal flow by factors such as perils, triggers, expected loss, and pricing, as well as analysis of the issuance trends by month and year.