The world’s largest reinsurance firm Munich Re believes that pricing for catastrophe bonds and insurance-linked securities (ILS) has stabilised at 2013 levels and expects it to remain broadly at current levels for the foreseeable future.
With cat bond and ILS pricing having been on a steady decline in recent years, analysis in the latest ILS market report from Munich Re’s Risk Trading unit shows that investors may have reached the bottom of their appetites for assuming risk at any cost and discovered where there cost of capital lies.
Excess capital from ILS funds and investors resulted in a tightening of risk spreads between 2011 and 2013, however indexed pricing from secondary cat bond and ILS markets shows that between 2013 and the present pricing has not declined any further, suggesting that cat bond pricing may have met investors’ minimum return requirements.
Seasonal price fluctuation aside, Munich Re says that all of the main perils in the ILS market are currently priced at levels which are similar to those seen in 2013. Munich Re also notes that there was no pricing movement in the market after the assumed triggering of the MultiCat Mexico Ltd. (Series 2012-1) Class C catastrophe bond notes by hurricane Odile in Mexico, which it puts down the size of the potential loss ($50m) versus relative to outstanding ILS and catastrophe bond capacity.
Munich Re says that it would expect pricing to remain around these levels in the coming months, without any further downward movement. This is aligned with a number of investors we’ve spoken to who said that they feel that for certain perils and at certain risk levels, catastrophe bond and ILS pricing cannot decline any further.
Interestingly, Munich Re has noticed a preference among investors for cat bonds with a higher level of risk lately in the secondary market. This makes perfect sense, given many of the recent cat bond issues have been relatively remote risks, with correspondingly low coupons.
With investors having targets to maintain it is natural that some capital would increasingly flow towards deals with higher risk and higher return.
Munich Re said that for U.S. wind cat bonds, a change in expected loss dependent pricing has been noted. U.S. wind cat bonds with an expected loss of 2% or greater are currently trading at lower spreads than seen in 2013, as investors seem to be drawn to these bonds in search of higher returns.
Higher expected loss cat bonds exposed to U.S. hurricane risks are often some of the best paying, in terms of coupon, so it makes perfect sense for these to be in demand at a time when issuance in 2014 has so far only seen an average expected loss of 1.51%. ILS investors need to access these higher risk bonds in order to achieve returns which can help to keep them on target with their returns.
We’ve been saying all year that the ILS market needs to see some higher risk issuance in catastrophe bond format in order to offer investors a little more for their portfolios. Munich Re believes that this trend witnessed in the secondary market, of investors being more attracted to higher risk, higher yielding cat bonds, could be reflected in upcoming issuance activity as sponsors take advantage of this appetite and also attempt to give investors what they want.
Munich Re is also bullish about the prospects for the catastrophe bond and ILS market in the fourth-quarter, joining others such as Aon Benfield Securities and Willis Capital Markets & Advisory, in suggesting that a strong quarter of issuance will be seen.
The main reason for these predictions is not just market conditions and an expectation that there is plenty of capital available to soak up new deals, it is the huge amount of maturing cat bonds coming up over the next few quarters. By Munich Re’s numbers $3.8 billion of cat bonds are due to mature in the next two quarters, freeing up considerable capital and also leaving sponsors with renewal opportunities.
Any sponsors of maturing catastrophe bonds will likely find much better value in a renewed cat bond, both from a pricing and terms and conditions angle, as the difference in the market now compared to three or more years ago (when most were issued) is stark.
Munich Re expects that sponsors will take advantage of this liquidity, by either renewing expiring deals or pursuing issuance of new cat bonds. With so much capital being freed up and with an expectation that key ILS investors will try to deploy more capital into the sector for the renewals, the market could find itself with sufficient capacity to support as much cat bond issuance as can be created.
Munich Re said that it expects a number of new cat bond transactions will be launched by year-end, with sufficient activity expected to take the 2014 issuance total past the amount seen in 2013. However the window of opportunity for sponsors will prevail into Q1 2015, said Munich Re, so we could see some deals rolling over to complete in January and more brisk issuance in the new year as well.
Interestingly Munich Re also highlights the option that sponsors have to delay their cat bond issue, to move it away from the busy January renewal period, pushing it back into Q1 by purchasing a bridge reinsurance cover to avoid any gap in reinsurance coverage. Of course Munich Re offers that kind of business itself and will be hoping to benefit from any sponsors looking to find a quieter time to issue their next catastrophe bonds.
You can download a copy of the full ILS Market Update Q3 2014 from Munich Re via its website here.