Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

ILS investors accept higher secondary market prices to put capital to work


This year has seen some unusual patterns in the secondary market for insurance-linked securities and catastrophe bonds. The unusual patterns began at the start of the year as mark-to-market losses were a feature which caused consternation for some investors. We then saw prices stabilise as we moved into the second quarter before seeing unseasonal price increases in May and June. The net result of this has been that investors have had to be selective in their capital deployments with some accepting higher prices to put capital to work.

The mark-to-market losses and price decreases seen in the first few months of the year were largely down to the high issuance activity in the primary cat bond market combined with selling pressure in the secondary markets. Interest in secondary market positions dropped as investors sought to put capital to work in newly issued transactions, many of which had attractive coupons. This gave some new entrants to the market an opportunity to put capital to work more cheaply, taking advantage of depressed secondary pricing. That trend didn’t last though and in fact it was seen to reverse in the second quarter.

The Q2 insurance-linked securities and catastrophe bond market report published recently by Aon Benfield Securities discusses the unusual pattern seen in the second quarter. At the start of Q2 there was significant demand for secondary positions. This was stimulated by strong capital inflows which meant that it was tough to put it all to work in the primary market. Primary issuance, while high still, was not enough to satisfy all of the capital that came into the market meaning that it had to be invested into secondary ILS and cat bonds. This resulted in strong trading volumes in the secondary market, but still there were insufficient bonds to meet the increased demand, according to Aon Benfield.

This lead to a bit of stagnation in the secondary market as ILS investors did not want to let go of positions as they feared being locked out and having no other ILS or cat bond opportunities to put their available capital into. This explains the slowdown in trading that was noticed as Q2 began to come to a close. Aon Benfield say that there were some opportunities to swap out positions. By the end of the second quarter frustrated investors, who didn’t want to sit on the sidelines of the market waiting for new issuance or for secondary positions to become available, began to pay higher prices for bonds to put their capital to work in the market.

While some of these patterns have been unusual when compared to previous years they are actually indicative of how a liquid market should operate with supply and demand impacting prices. Often the secondary ILS and cat bond market is criticised for a lack of liquidity, and while it’s not as liquid as many markets these patterns show that the market is operating relatively efficiently.

Aon Benfield say that they saw the following price increases (on average) during the second quarter. U.S. hurricane cat bonds increased by 0.85%, U.S. earthquake by 0.95%, European exposed bonds by 0.29% and Japanese exposed cat bonds rose by 0.87%.

The excess capital in the market, and sitting on the sidelines, is going to have an impact on Q3 transactions according to Aon Benfield. They expect upcoming transactions will be rewarded with lower spreads due to the demand from investors, this has already been evidenced in the last few transactions. They also expect spreads to continue to narrow as we progress through the U.S. hurricane season.

You can access the full report from Aon Benfield Securities via their press release here.

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