EIOPA: Increased volume of catastrophe bond issuance is astonishing

The European Insurance and Occupational Pensions Authority (EIOPA), one of the three supervisory entities in the European System of Financial Supervision and responsible for the insurance, reinsurance and pensions sectors, has published its latest Financial Stability Report for the first half of 2012. The report looks at issues affecting the financial stability of the re/insurance and occupational pensions sectors and highlights any current of future weaknesses or opportunities that they see.

We’ll start with a summary of some of the key points in the report which are relevant to re/insurance. The report states that the majority of insurance groups remain well capitalised in 2012, despite the extreme losses of 2011, however EIOPA see’s a solvency capital ratios beginning a decreasing trend. The report discusses some of the key issues facing the sector and they highlight the low-interest rate environment and the financial and economic climate as risks to the sector.

As part of these reports the EIOPA asks member companies to report back what they see as the most pressing risks they face. The responses listed sovereign risk, equity risk, low-interest rates and the credit worthiness of banks as the highest risk factors for Europe. Other risks highlighted include personal and household credit, property, natural catastrophe, currency, liquidity and the risk of a sharp rise in interest rates.

Lately, EIOPA says, the insurance industry is seeing a reversal of the positive development seen last year. This is evident in solvency ratios, profitability and to some extent premium growth. Despite this they say that Solvency I levels remain satisfactory for the sector. Naturally the Eurozone economic issues remains the biggest threat to the insurance sector. On the reinsurance sector, EIOPA is mostly complementary but highlights that rate rises have not been as widespread or high as many expected or wanted. On occupational pension funds, EIOPA identifies the main issues facing the sector as sovereign risks, equity risks, bank credit risks, low-interest rates and of course longevity risks. When members in the pensions sector were asked what the greatest risks to themselves was they ranked longevity risk as having the largest potential impact although not having the highest probability of occurrence.

And so onto catastrophe bonds. The EIOPA reports don’t often discuss the insurance-linked securities or catastrophe bond space but given the increased profile of the sector and increased issuance this year it gets a mention. The report says that the increased flow of capital into the reinsurance sector can also be observed by looking at the insurance-linked security market. They highlight the record issuance activity that the market has seen in the first quarter of 2012 and that the second quarter has also been healthy (although not record-breaking).

The EIOPA report points out that the increased volume of catastrophe bond issuance is astonishing given the fact that three cat bonds were total losses last year due to catastrophe events. This is a very good point and often overlooked by commentators on the market (including us). 2011 saw the most losses in the cat bond markets history, with Muteki Ltd. defaulting on the Japan earthquake and Mariah Re Ltd. Series 2010-1 and 2010-2 defaulting on tornado losses in the U.S. The fact that the market not only kept functioning but actually increased in activity is testament not only to the market participants addressing any issues these losses raised in future transactions but also to the need for reinsurance capacity that the cat bond market now fills.

EIOPA says that as the cat bond market continued to function through 2011 and into 2012 these events were apparently a successful test for the cat bond and ILS market. EIOPA expects the market to continue to grow, especially given recent issuance levels. They close this section of the report by saying that although the cat bond and ILS space is small when compared to the securities market as a whole and the overall reinsurance market, when compared with the property-catastrophe reinsurance market it is significant.

You can access the full report from EIOPA in PDF format here.