The latest insurance-linked securities (ILS) and catastrophe bond market report from Willis Capital Markets & Advisory, the investment banking and advisory arm of broker Willis, raises some very good questions that the ILS market may want to put some thought into if it is to continue its recent rapid pace of growth.
The report from WCMA, ILS Market Update – The storm before the calm, contains all the details and statistics on the catastrophe bond transactions that Willis counted as occurring within the second-quarter of 2013. It also features an interesting interview with Luca Albertini of Leadenhall Capital Partners LLP as well as statistics and figures on the outstanding cat bond and ILS market.
However, you can download the report from Willis’ website (link at the bottom of this article) to read it in full and we thought we’d focus on a number of key questions and issues that WCMA believes the ILS market should be asking itself. WCMA notes that the summer months tend to be slower in terms of issuance, with more deal planning than deal making going on, making this an ideal time for the ILS market to be asking itself some open questions about the markets future and potential for growth.
First on WCMA’s mind is the topic of broadening the market out beyond its current remit of peak natural catastrophe perils into other geographic areas and classes of re/insurance business. Key to the growth of the catastrophe bond and ILS market, as well as the rest of the collateralized and third-party capital backed reinsurance sector, is its ability to expand beyond its typical natural catastrophe perils.
Bill Dubinsky, Head of ILS at WCMA, commented that; “To continue the same pace of growth we have seen in the last few years the ILS market will need to accept a growing pool of perils.”
Of course this isn’t just a case of one side of the deal needing to broaden its acceptance of risks and perils, sponsors need to deliver on a broader set of risks and investors need to be prepared to allocated capital to support a wider reaching market in ILS, cat bonds and collateralized reinsurance.
Dubinsky added; “Some of these new perils are evolutionary, not revolutionary – such as earthquake risk in areas like Colombia, Chile, Israel and even China. Others may represent a more radical departure from market norms. For example, will investors accept standalone US terrorism risk if TRIPRA (the Terrorism Risk Insurance Program Reauthorization Act which is due to expire on
December 31, 2014) is not renewed? Will casualty risk finally become more at home in the capital markets?”
The second question WCMA raises is one of terms and conditions on ILS and cat bond transactions. Alongside the decrease in spreads seen in recent months, an increasing flexibility in cat bond terms and conditions, such as variable resets and new storm definitions, has also helped to drive market growth.
WCMA notes that to some degree investors can price these changes into their acceptance of deals and should welcome the added flexibility if it helps to bring new sponsors and more deals to market. If the ILS and cat bond market continues to apply rigorous high standards to structure and collateral mechanism, as has been the case since the financial crisis, this is particularly true, said WCMA.
However, if we have a few poorly structured deals, where flexible terms result in opaque structures that investors cannot easily understand and price, then investors could assume the worse, that all deals have hidden ‘time bombs’, and price transactions accordingly. That would clearly be bad for the market and thankfully we haven’t seen any specific instances of deals being priced up due to unorthodox terms and conditions or structures for a number of years.
WCMA says that the market has handled the increased flexibility in transactions well, responding to more aggressive deals with pricing adjustments and more targeted bookrunning to investors to investors who believe themselves capable of pricing these new transactional features in recent catastrophe bonds.
The third question WCMA raises relates to the reduced pricing being seen and asks how reinsurance firms and partners will react to the lower, and more competitive, ILS and collateralized reinsurance pricing environment. This could play out as reinsurers accessing ILS and catastrophe bonds more themselves as a form of risk transfer capacity, but WCMA asks whether that could lead reinsurers to pass on savings made at reinsurance renewals allowing them to become more competitive.
That’s an interesting proposition, traditional reinsurers leveraging capital markets capacity to cheapen their own risk transfer enabling them to pass on the cost savings to their own clients. That is an interesting pipeline of risk forming, which would see the peak, reinsured risks, ending up with third-party investors from the capital markets. An interesting prospect to consider.
An alternative that WCMA raises as a possible future, might be that as the profitability in U.S. catastrophe reinsurance falls, could that put upwards pressure on pricing of non-U.S. catastrophe reinsurance business? And if that were to happen would we then see more non-U.S. catastrophe business entering the capital markets via ILS? Again, an interesting prospect. The dynamics that WCMA discusses are all going to play out over the next year or so, if ILS pricing remains competitive or cheaper than traditional reinsurance, which will make watching this market extremely interesting.
The fourth question that WCMA raises in its report is one of timing of ILS and catastrophe bond issuances. WCMA says that for incumbent sponsors the thinking has moved from if to when they should issue their next cat bond or ILS deal. These sponsors are now totally bought into the ILS market as a source of risk transfer capacity and there is more to be gained by timing issuance of a new deal than ever before due to increased investor appetite and the pricing environment.
WCMA notes that insurers have typically been resistant to timing in the market in the past, but that this could be changing. Timing of ILS and cat bond issuance, is becoming increasingly important for sponsors to be aware of and by strategically choosing the best time to place a deal sponsors can benefit from reduced pricing or increased investor appetite.
We saw evidence of timing this year in a number of cat bonds where repeat sponsors came to market earlier than expected in an effort to be first out of the gate with a new cat bond deal. This allowed them to tap investors strong appetite for new issues and upsize their cat bonds considerably.
WCMA notes that as well as timing, other factors which can enhance ILS execution include the tranching of a deal as well as other structural and reinsurance program design decisions. Timing could have a bearing on issuance for this year, especially as there are a lot of cat bonds scheduled to mature right at the end of 2013.
Finally, the fifth question on the ILS markets mind should be the Atlantic hurricane season and other potential surprises in the form of large catastrophe loss events. WCMA notes that the wrong storm or earthquake in the wrong place could change the market dynamic that we currently see very quickly.
In terms of a forecast for the rest of 2013, WCMA suggests that issuance could reach the $7 billion mark, with a chance of being higher if some of the deals maturing at the end of the year are brought forward to be re-issued in December.
Bill Dubinsky said; “Our current best estimate for where the ILS market will end up in terms of issuance at the end of the year is $6 to $7 billion in non-life issuance (excluding private deals). If sponsors accelerate deal execution into 2013 that would otherwise have occurred in 2014, exceeding $7 billion seems quite possible.”
It’s worth noting here that Willis’ WCMA does not count privately transacted cat bonds and so its figure for ILS issuance for the first-half of 2013 is for $3.8 billion of deals, compared to our figure of just over $4.08 billion, as recorded in our Deal Directory. As we wrote last week though, we now record over $5 billion of deals issued in 2013 in our directory based on including the latest cat bonds that are still being marketed.
You can access the full report from Willis Capital Markets & Advisory via its website. We will cover other insights from the report over the coming days.