While the catastrophe bond market has been first to experience investor-demand and capacity driven softening, as spreads have increasingly tightened on primary issues over recent months, this isn’t yet reading across to the entire collateralized reinsurance market at the mid-year renewal season, we’re told.
2021 has seen a significant upwell in demand from investors for new catastrophe bond investments, which has driven strong execution and keen pricing to the benefit of sponsors, but resulted in year-on-year softening in that market.
As we’ve been explaining over recent weeks, spread tightening in the catastrophe bond issuance market has now driven multiples to levels last seen in 2019.
The reason for the spill-over to ILW’s is that investors are keen to access returns linked to reinsurance in 2021, but the more simple, named peril focused contracts appear to have experienced the majority of the excess investor interest through the start of this year.
As that interest began to drive cat bond multiples down, some of the established cat bond investors have increasingly looked to ILW’s as well, with capacity turning its attention to that segment of the reinsurance and retrocession market resulting in year-on-year softening there.
So, investor demand is highest for cat bonds right now, given they are typically easier to understand and also to access.
This has driven the trend for upsizing and spread tightening of almost every cat bond issue, as well as this spilling over of demand into ILW’s.
But, while cat bond and ILW rates-on-line have softened year-on-year, it’s interesting that collateralized reinsurance and retrocession renewals are still achieving year-on-year rate increase, following along with broader reinsurance market pricing trends.
As we’ve been reporting in our coverage of the mid-year 2021 reinsurance renewals, analysts have said that while reinsurance rate increases for June and July won’t be spectacular and increases will come in lower than anticipated, they do still represent year-on-year compounding increases across the majority of the marketplace.
Speaking to collateralized markets, including ILS fund managers, it seems that collateralized reinsurance and retrocession renewals have not been exhibiting the capacity and demand-driven softening seen in catastrophe bonds and ILW’s.
Partly, we understand that the broader coverage offered by collateralized writers, who sign onto reinsurance and retro renewals on the same terms as rated balance-sheet reinsurers, as well as the greater exposure to factors related to social inflation that can potentially heighten uncertainty related to loss creep and ultimately trap collateral, are additional elements that ILS funds and those writing collateralized business want to be properly compensated for taking on.
After the recent year’s of major catastrophe losses, along with the resulting loss creep and challenges dealing with trapped collateral, this is perhaps further evidence of the disciplined approach to this renewals that has been reported from the ILS market.
Price increases at this renewals are still largely seen as attractive for ILS players, given they are compounding on top of those achieved last year.
Although there is definitely an element of disappointment in the pricing on higher reinsurance layers, where the greatest demand is being seen from both traditional and ILS capital, we understand.
ILS managers continue to seek to improve the quality of their portfolios through negotiation on terms and conditions as well, we’re told, which alongside price improvements is helping to make ILS portfolios more predictable and in some cases more robust.
The higher layers of Florida property catastrophe reinsurance programs are likely to experience the lowest rate increases, given these compare most closely to cat bonds, in terms of the layers of risk they cover and their exposure being largely to the really major catastrophe loss events.
While lower, or working layers, are likely to see collateralized reinsurance writers securing high single-digit to low double-digit increases, depending on the prior year performance of the ceding company.
Underwriters of collateralized retrocession are also expecting to secure compounding rate increases at the mid-year renewals, as these areas of the market remain some of the most dislocated by capacity pull-back from recent years.
Which is a different experience to the ILW market, or with industry-loss trigger catastrophe bonds, which have both softened.
So, what are we seeing here?
Is this a bifurcation of the ILS market, with the more predictable and formalised, securitised, structures such as catastrophe bonds becoming a little cheaper, given there is greater certainty in what’s covered and how it could become exposed to losses, as compared to the collateralized market where greater uncertainty and risk of prolonged trapping of collateral is seen as more evident?
Logically, that does make some sense, given the difference in the structures and markets, as well as the way capital can move in and out of them.
But it’s not something we’ve really seen before, as catastrophe reinsurance and retro has tended to head quickly in the direction of cat bond pricing when that has moved in the past. Or cat bond pricing has followed on the heels of the traditional market.
In our conversations with some of the newer investors to the catastrophe bond market in recent months, it’s clear that given the broader economic and macro financial environment, the value of an alternative asset class exhibiting low correlation, while having easier entry and secondary liquidity is seen as particularly high at this time.
That’s resulted in some new capital with a particularly low-cost associated with it come into the market it seems, helping to drive the softening of cat bond pricing and the resulting overspill into ILW’s.
Eventually, we would expect to see some overspill and therefore ramifications for broader reinsurance pricing and it’s entirely possible that the softening in cat bonds and ILW’s is holding back reinsurance rate gains. But so far that doesn’t appear to be turning reinsurance and the broader market is maintaining its discipline, including ILS players writing collateralized business.
If this persists, it does open up an interesting opportunity for the catastrophe bond market to continue driving home the capital efficiency advantage of the protection it can offer, which should continue to stimulate the high issuance levels recently seen.
But at the same time, cat bond funds and investors must be careful not to push too hard, or they do risk giving away rate needlessly, when rates could perhaps have been kept more aligned with where the broader reinsurance market is currently pegged.
Of course, there’s always time for some last minute softening, but as so many of the June renewals are now negotiated and in some cases completed weeks earlier, it seems unlikely things will move dramatically between now and the 1st, for Florida’s renewals at least.