The market for insurance-linked securities (ILS) and catastrophe bonds lost some of its recent momentum in the first-half of 2015, with a decrease in the number of new cat bond sponsors and the emergence of a pricing floor largely responsible, according to Munich Re.
The Risk Trading unit of the world’s largest reinsurance firm Munich Re notes that during the first-half of 2015 just two new catastrophe bond sponsors came to market, the $100m Manatee Re Ltd. (Series 2015-1) from Safepoint and the €200m Azzurro Re I Limited from UnipolSai.
Munich Re counted $4.7 billion of new issuance in the first-half of 2015, but remember that the reinsurance firm only reports on 144A cat bonds and does not include the full range of private or life ILS transactions that we cover. Hence it’s figure of $4.7 billion is significantly lower than the $5.224 billion first-half number that Artemis reported.
Dr. Andreas Müller, who heads up the Risk Trading Unit at Munich Re, explained; “With a total issuance of $4.7bn during the first half of 2015, the market has maintained its overall drive after growing substantially over the last three years. However, issuance did lose some momentum in comparison to 2014, in which issuance had amounted to $6bn in the first six months.
“One main reason for this is the reduced activity of new sponsors in the market, coupled with a visible recovery in risk premiums, which did not see further downward movement in 2015.”
Compared to the prior year, which saw 8 new sponsors bringing cat bonds to market in the first-half of 2014, the other major difference of course is the size of the Florida Citizens Everglades Re issue, which alone can make up a large amount of the difference.
Munich Re believes that the refusal to keep dropping risk premiums has also affected issuance, something which has been seen with the withdrawal of some cat bonds after investors refused to come down to the sponsors pricing aspirations.
“A look at indexed secondary market risk spreads reveals that the downward trend in ILS risk premiums over the last several years has come to a halt in 2015, as many investors’ willingness to reduce their return requirements has been exhausted,” Munich Re’s report explains.
The chart below clearly shows the pricing adjustment, with an uptick in 2015, alongside issuance by half-year.
But this should be viewed as encouraging for the ILS market and for the market to have seen the level of issuance that has come to market so far in 2015, while pushing back on pricing and also on terms, is perhaps a strong sign of the acceptance that cedents now have for catastrophe bonds and other ILS.
Munich Re notes that despite the floor on pricing seemingly having been reached, issuance conditions remain attractive to sponsors and the reinsurance firm expects that this will continue throughout the remainder of 2015.
Munich Re’s report notes that the variable reset should now perhaps be considered a standard catastrophe bond or ILS feature, with 10 of the 12 deals it tracked in during the second quarter featuring one.
Additionally, Munich Re feels that the “persisting overhang of capacity” has resulted in improved terms for sponsors, such as longer durations, as well as an ongoing increase in indemnity structures.
This persistent overhang of capacity is largely provided by “reinsurance-savvy dedicated cat funds catering to the bulk of pension fund money” Munich Re explains.
These trends, of ample capacity, experienced investment managers with long-term investors behind them, is benefiting the ILS sponsor base, according to Munich Re. Cedents can buy “more and more reinsurance-like capacity in a collateralized, multi-year format” Munich Re says, with enhanced terms and the inclusion of more non-modelled perils and a high number of aggregate structures, further evidence of a buyers market.
Munich Re also notes the resurgence, to a degree, of the parametric trigger in cat bonds, as sponsors that benefit from immediate liquidity after an event become more discerning in their risk transfer purchases.
Looking ahead, Munich Re’s Risk Trading unit notes that ILS investors remain “hungry for diversifiers” which is resulting in high demand for anything outside of the peak U.S. perils.
Dedicated catastrophe funds are driving demand for diversification, and there is some evidence that non-U.S. sponsors have been responding in the growing share of Japanese and other diversifying peril region cat bonds coming to market in the last three years.
“As vendor models are extended to more regions and dedicated cat funds open for exotic, non-US perils, we expect this trend to continue and new perils to be added to the market in the future,” Munich Re continued.
Munich Re expects that the current pricing environment will persist through the rest of this year, helping to keep conditions attractive for sponsors of ILS and catastrophe bonds.
However the reinsurer is not bullish for another record year, forecasting just another $1 billion to $2 billion of issuance over the second-half, which would not be as impressive as many investors are hoping for.
Munich Re does expect that issuance will perhaps focus on higher expected loss layers, as investors are “increasingly open to boost their yields by allocating capital into higher risk levels.” This means deals in the expected loss range of 2% to 5% are seeing stronger appetite from investors, enabling pricing to be kept down and Munich Re expects to see more in this range.
“For the remainder of 2015, we expect issuance of $1bn to $2bn, bringing total issuance north of $6bn. Sponsors seeking to place non-US perils and new exotic risks are expected to encounter attractive terms, with dedicated cat funds keen to diversify their portfolios,” Müller commented.
A couple of additional thoughts. The decrease in new sponsors could simply be cyclical, with cat bonds being multi-year coverage and there being a finite number of new sponsors available in any one year. It’s also likely a result of very low traditional reinsurance pricing, which has perhaps made staying with the ‘devil you know’ preferable in 2015 for some potential new sponsors.
The pricing floor has resulted in some pull-back from ILS issuance by a couple of sponsors that pulled deals when they couldn’t achieve the pricing their had been hoping for. However, as Willis said the other day, sponsors are risking missing out on an opportunity to integrate ILS into their reinsurance programs, so as long as ILS markets can maintain the floor this is unlikely to result in any meaningful reduction in issuance.
Partly both of these factors are due to the continued strong competition between traditional and alternative capacity, something which will cause the ILS market to ebb and flow. How it shakes out over the coming five years or more, once we see some more typical catastrophe loss years, is where it will get really interesting.