The pace of decline shown by insurance-linked securities and catastrophe bond premiums or rates has continued to slow down in the first-quarter of 2014, according to the latest analysis from ILS consultancy Lane Financial LLC.
This continued the trend witnessed in the final quarter of 2013, when Lane Financial reported that ILS and cat bond premium declines had slowed. This deceleration of ILS and cat bond premium declines has continued through the first-quarter of this year, but rates have dropped further and remain at their lowest level since before hurricane Katrina.
As is typical, the report from Lane Financial is a considerably more technical look at the ILS and catastrophe bond market over the last year, with commentary on market conditions, pricing, trends in terms of deal flow, as well as detailed statistical analysis of the outstanding market.
The latest Lane Financial LLC ILS market report is titled ‘Straw Hats in Winter – Annual Review for the Four Quarters, Q2 2013 to Q1 2014.’ Lane Financial discusses the current buyers market conditions in reinsurance and ILS, saying that the time to buy protection is often when others are scrambling to write premiums, a good description of the market right now.
The fact that the ILS and reinsurance markets are softening is not debatable, according to Lane Financial. In fact the firms measure of ILS and cat bond market rates, the Lane Financial synthetic rate-on-line index which uses data from both the ILS and ILW markets to give a reasonable approximation of premiums being paid (or rate-on-line) for ILS and cat bond transactions, clearly shows just how soft the market has become.
The Lane Financial synthetic rate-on-line index has recorded a 28.5% drop in premiums since the 31st March 2013. The index sat at 123.4 a year ago, when Lane Financial said that the rush of capital was creating a soft ILS market. At the end of March 2014 the index had declined to 88.2 at time of publishing, which is the 28.5% drop in premiums.
Despite this hefty drop in ILS premiums Lane Financial believe that we are approaching the bottom of the rate decline and that ILS and cat bond premiums have decelerated their downward fall significantly.
The report explained; “We believe premium changes are flattening out. Premiums may go sideways for a while, maybe even a long while, but for the record we believe the next surprise will be to the upside.”
So let’s look at how the index has measured these rate declines over the last year or so. Quarter by quarter the index has fallen almost consistently over the last two years, barring one small rebound after hurricane Sandy impacted market pricing. In the fourth quarter of 2013 the index declined to 92.9, a drop of 7% since the end of Q3 2013, having fallen by 16.2% the quarter before that.
By the end of the first-quarter of 2014, sitting at 88.2, the synthetic rate-on-line index had fallen by just 5%, which is a considerably lower rate. At 88.2 the index now sits over 51% lower than was seen at its high point in mid-2009.
It is worth noting that we really need to see another few quarters of this data to fully understand just how much ILS premium rates decline is decelerating. A 5% quarter on quarter decline could very easily translate into a 20% annual decline if the trend continued.
With recent catastrophe bonds displaying further price drops and the upcoming mid-year reinsurance renewals promising to show further rate declines on property catastrophe risks it is hard to forecast when the trend will truly flatten yet. We may know more in six months time.
Lane Financial believe that we are approaching that point and that the next major movement in ILS premiums or rates is likely to be an upward one in reaction to a major catastrophe event. How long premiums go sideways for, once they do flatten, is an interesting question. Will we ever see such peaks and troughs as the Lane Financial index graph above shows or will we see something more similar to the pre-Katrina years with smoother upwards or downwards index trajectory?
Lane Financial notes that supply-side trends are being driven by insurers and reinsurers taking advantage of pricing and terms in the catastrophe bond market. The report states; “Looked at from the supply side (i.e., the issuer’s side) it is evident that traditional reinsurers are buying “straw hats in winter”. The issues coming to market display surprisingly clear symptoms of buying cheap protection.”
The report notes trends which show that buyers are taking advantage of pricing to top on their reinsurance and retrocessional protection, not just as a reaction to the availability of cheap capital but also as a reaction to the improved terms and conditions available to buyers.
One of the most interesting charts in the report is one showing how terms and conditions for ILS and reinsurance have been increasingly relaxing over recent years. The hard market periods seem to be having an increasingly muted impact on this as relaxation of terms and broadening of coverage takes hold.
Lane Financial highlights that the trend towards softer terms and conditions has continued over time, with some tendency for terms and conditions to be tightened up under hardening market conditions only to be relaxed even further when the next softer market emerges.
With the general softening of the ILS and catastrophe bond market, both in terms of premiums or rates and terms and conditions, it is no surprise to see that potential returns achievable by investors are sliding as well. Lane Financial’s report shows that an annualised return for its index of returns for the first-quarter of 2014 was just 6.89%. Compare this to an 11.07% return for the full-year 2013 and its clear that recent return trends are set to reduce those achievable by investors and investment managers.
The report is lengthy and contains a lot of very detailed analysis on the ILS market, which we will not attempt to reproduce here. We recommend you visit the Lane Financial website and download a copy of the full report.