As the global effects of the Covid-19 coronavirus pandemic were being felt across financial markets earlier this year, the insurance-linked securities (ILS) market was not immune and Swiss Re notes that the dislocation caused ILS new issuance spreads to widen by 20% to 30%.
The uncertainty that “riddled” the global financial markets spilled over into the ILS space, causing challenges for the issuance of catastrophe bonds and other ILS structures for a time.
Depending on the risks being offered, ILS and cat bond new issuance spreads widened by as much as 30%, reinsurance firm Swiss Re’s Capital Markets team explained in its latest market report that was published today.
It was in stark contrast to the beginning of 2020, when catastrophe bond and ILS issuance was strong and the sector had ample capital, resulting in spreads tightening through January and March.
But the pandemic changed everything, driving a rush to liquidity in the secondary cat bond market and pushing up spreads there, which pushed spreads in the primary ILS issuance market as well once issuance resumed following a short roughly three week pandemic-related hiatus.
Swiss Re Capital Markets explained in its new report, “That dynamic quickly changed with the implications to the broader financial markets at the start of COVID-19 global lockdowns. While almost all other asset classes were in freefall, the ILS market did experience a dislocation with spreads widening as certain investors were forced to raise capital.
“Remarkably similar to the financial crisis over a decade ago, the ILS market remained liquid, which allowed investors that had cash to take advantage of the widening spreads. Certainly the widening of ILS spreads didn’t impact valuations to the same degree as broader credit instruments.
“However, the financial markets were extremely volatile during this time and the overall uncertainty of the world economic impact from COVID-19 created a pause in debt issuances including the ILS market.”
With spreads widening and as a result the return potential of holding catastrophe bonds to maturity rising, it was inevitable that some new capital would be attracted to the sector.
We’ve highlighted before that some cat bond funds managed to raise capital right in the heart of the pandemic, to take advantage of the opportunity available in buying up secondary bonds, as well as in the new issues that came to market offering higher-returns.
Swiss Re’s Capital Markets team also saw this trend, explaining that, “We have recently witnessed a new influx of capital to take advantage of these wider spreads, which has resulted in a stabilization in the ILS market.”
One of the reasons spreads rose on primary issues was the fact they had been pushed up by the selling pressure in the secondary market.
Swiss Re’s Capital Markets team said, “This caused spreads on new issuances to follow the trend of the secondary market to stay competitive for investor capital.”
But the other reason is the generally accepted notion that the pandemic caused investor costs-of-capital to increase, something ILS end-investors were acutely aware of and as a result higher returns were demanded for capital to be deployed.
“SRCM observed newly announced catastrophe bonds being offered at much higher interest spreads to expected loss multiples, relative to where deals had priced in January and February for similar cat risks. As a result, the first half of the year demonstrated a much higher average spread to expected loss multiple compared to 2019, with a year over year increase of roughly 18%,” Swiss Re explained.
Helping the ILS market to remain robust throughout the last quarter was the ability of investors to attract new capital, despite the global challenges faced in financial markets and the uncertainty facing investors.
Swiss Re’s Capital Markets team notes that while, “Some ILS fund managers were fearful of fund redemptions, as well as the drawn-out losses from events in 2017 and 2018.”
The dynamics in the market meant that, “Instead of being faced with those redemptions, investors were able to raise funds.”
Capital in the market, plus “moderate inflows to fund managers,” drove a trend of tightening secondary spreads towards the end of the first-half of 2020.
“The relative stability of the ILS market throughout this period and rate increases seen across the (re)insurance industry proved to be attractive.
“The primary market was able to reap the benefits of investors holding large sums of cash, and the fiduciary responsibility to put that cash to work,” Swiss Re Capital Markets explained.
It’s a positive story, explaining how the insurance-linked securities (ILS) market managed to avoid too significant an impact from the pandemic, at least in the more liquid catastrophe bond segment of the space.
It bodes well for the end of this year, as now with reinsurance and retrocession rates firming and spreads still wider for ILS issues, there is a chance for the ILS market to see another period of bumper issuance later this year and into 2021, if the capital is available at competitive rates.