The continued and accelerating growth of the insurance-linked securities (ILS) and catastrophe bond market demonstrates the increasing acceptance of ILS as an alternative asset class, according to the world’s largest reinsurer Munich Re.
Reinsurance firm Munich Re’s Risk Trading unit, which assist Munich Re clients to access the capital markets and ILS structures, while also providing capital market support for the reinsurers own retrocession needs, has published its latest report on the ILS market.
In it the reinsurer acknowledges the continued and accelerating growth of the ILS and catastrophe bond issuance market, leading to record issuance in 2014. Munich Re recorded $8.4 billion of cat bond issuance in 2014, noting that of the 29 deals that came to market 9 were from new sponsors showing the markets increasing appeal as a source of risk transfer.
In 2014 the ILS market also became even more accepting of aggregate covers, with over 40% of the total catastrophe bond issuance involving aggregate protection.
At the same time indemnity triggered protection became even more the norm, as indemnity triggers grew their share of the cat bond market to over 70%. Andreas Müller, Head of Origination, Distribution and ILS Investments at Munich Re, said that this shows that the ILS investor base “Feels increasingly comfortable with underlying insurance portfolios and exposure characteristics of cat bond sponsors.”
At the same time, “Since indemnity triggers do not present cedents with the concerns of basis risk this “new normal” has made the cat bond market more reasonable for cedents,” Müller explained.
“Another year of growth demonstrates the ILS market’s increasing acceptance as an alternative asset class,” the report explains.
2014 was the third year in a row when “material capital inflows” lifted the size of the market. Munich Re puts the growth of the outstanding cat bond market at 21%, up to $23.2 billion at year-end (note, Artemis recorded $25 billion+ due to the inclusion of some private and life deals).
Munich Re put the annual issuance volume at $8.4 billion in 2014 (again below the $8.8 billion Artemis recorded). Interestingly, Munich Re notes that the amount of U.S. wind cover afforded by the cat bond market at the end of 2014 was roughly the size of the entire cat bond market just three years ago.
The report also notes the increasing average size of catastrophe bond issues, with over 60% of the deals recorded in 2014 reaching $200m or greater in size, when 50% were under $200m in 2013. In fact, Munich Re notes that a quarter of placements in 2014 were $400m or larger, while the year also saw the largest cat bond ever in the $1.5 billion Everglades Re Ltd. (Series 2014-1).
Institutional investors accessing the ILS and cat bond market through specialist ILS fund managers were responsible for the majority of the capital inflow in 2014. These funds increasing sophistication and ability to source, analyse and underwrite reinsurance risks has also helped to drive the increasing volume of indemnity deals, the report says.
Indemnity triggers are no longer the sole domain of repeat sponsors of cat bonds either.
“The increased comfort of institutional investors in assessing non-standard indemnity risk was also demonstrated by the fact that indemnity triggers were used evenly by repeat and first-time issuers,” explains the report.
Of course one of the main features of the catastrophe bond market in 2014 has been the continued decline in rates, although seemingly at a slower rate than in 2013 as Artemis wrote here recently. Munich Re notes that on a seasonally adjusted basis rates for U.S. wind decreased by 8%. However the reinsurer says that it believes the declining rates trend could level off in 2015, as rates reach the minimum return requirements for investors.
The declining risk adjusted return of catastrophe bonds is graphically illustrated below, also showing the slight uptick in Q4. Investors return requirements are expected to drive them to explore deeper; “Into the levered ILS product spectrum, including sidecars and certain collateralized reinsurance placements,” the report explains.
Munich Re has a similarly bullish outlook for 2015 as other market commentators. The report cites the large amount of scheduled maturities and the expectation that repeat sponsors will seek to capitalise on investors reinvestment demand. At the same time there is an expectation that more first-time sponsors will be attracted to ILS and cat bonds by market conditions.
In 2015 Munich Re expects cedents will make increasing use of aggregate structures, as the ILS investor community is willing to accept more risk in this form. At the same time increasing amounts of pension fund capital are expected to grow the ILS pot even further, although it notes that how the capital is deployed may change to a degree, likely as a reaction to lower spreads but also to continued innovation in terms of structures.
The cat bond market may lose market share to private ILS and colateralized reinsurance, Munich Re notes, as the specialist ILS funds continue to shift towards private structures as a response to lower yields.
“The increased availability of leverage for both this product class and the expanding sidecar market has attracted multi-strategy hedge funds back to the scene, and we believe their demand will further drive the issuance of levered, high-risk products,” the report states.
This is a natural progression of ILS, as investors and fund managers become more sophisticated and better able to source higher yielding risks. However there is a portion of the investor base that would continue to appreciate catastrophe bonds and 144A ILS, due to their mandates, which should ensure further growth of the market, albeit at a slower rate than collateralized reinsurance.
Another interesting fact from the report is Munich Re’s believe that “material demand is building up in remote risk transactions.” This is interesting as in a market where yield is reducing you might think that lower risk, lower return deals would be less popular.
However, Munich Re believes that remote risk ILS transactions could become a cash substitute for generalist investors who do not follow specific ILS strategies. That could be a big deal for ILS, helping more capital into the space and passing off the really remote risks to a more mainstream institutional investor market. It will be interesting to watch for this development in years to come.
Market conditions provide “A sound basis for the deal pipeline in the upcoming months,” Müller says. Whether this results in another record year or not remains to be seen, but the future looks bright for cat bonds and ILS.
Munich Re’s latest ILS market report is available from its website here.
Artemis’ Q4 2014 Catastrophe Bond & ILS Market Report – A busy finish to a record year for ILS
We’ve now published our Q4 2014 catastrophe bond & ILS market report.
This report reviews the catastrophe bond and insurance-linked securities (ILS) market at the end of the fourth-quarter of 2014, looking at the new risk capital issued and the composition of the cat bond & ILS transactions completed during Q4 2014. It also includes a brief review of the full-year 2014’s record issuance.