ILS response to disasters could drive 20% cat bond growth: John Seo, Fermat Capital


Insurance-linked securities (ILS) demonstrated the value of its protection offering last year and the capital markets are expected to respond to the need for additional capacity to help close the expanding disaster gap in 2018, which could result in cat bond market growth of 20%, according to John Seo of Fermat Capital Management.

The catastrophe loss experience witnessed in the second-half of 2017 highlighted the lack of insurance penetration in both emerging and more developed parts of the world, and also the “gross under-preparedness” of the re/insurance sector to meet the cost of insured disasters.

This is according to Seo, Co-founder and managing principal, Fermat Capital Management, LLC, who in an article published by GAM Investments in March, noted the growing, global disaster gap (disparity between economic and insured losses post-event) and the increasing role the ILS market is playing in helping to narrow this gap, as it matures and expands it remit.

“The additional capital required to meet this growing gap between insured coverage and the expected losses from potentially devastating and highly remote catastrophes is larger than the (re)insurance industry currently has on hand and requires a solution outside of the traditional (re)insurance arena.

“Responding to this need, at a time when investors are searching for both yield and non-correlated investments in market conditions where increasing interconnectedness makes finding assets with truly diverse return streams challenging, capital markets solutions are bridging this structural gap,” said Seo.

In recent times, the ILS market has really expanded, ultimately claiming a larger slice of the overall reinsurance market pie, which, following 2017 catastrophe events meant that many investors in the ILS space suffered losses for the first time.

But unlike some had suggested this didn’t scare the ILS investor base, and Seo highlighted that the sector proved itself in 2017, with further, substantial growth expected in the months ahead.

“Having demonstrated their value in 2017, ILS represents a permanent and growing source of capital for managing the world’s risks. In the aftermath of losses, the ILS market is set to grow, with the cat bond market size alone expected to increase by 20% in 2018,” said Seo.

After a record-breaking level of catastrophe bond and ILS issuance in 2017 combined with the impacts of losses, growth in the cat bond sector alone of 20% in 2018 might have previously sounded somewhat ambitious.

However, Artemis’ data shows that cat bond issuance in the first-quarter of 2018 was truly huge for the period, at a record $4.24 billion, and combined with the response of the market to 2017 events suggests significant growth is definitely possible in 2018. In fact issuance is now at $5 billion for the year, according to our numbers, with much more of the second-quarter still to run.

Depending on which firms’ issued and outstanding catastrophe bond and ILS data is used, the amount of new issuance required in 2018 to achieve growth of 20% from the end of 2017, varies.

According to our research, it seems that issuance in 2018 will need to be somewhere between $11 billion and $13.5 billion in order to offset the $6.9 billion of maturities scheduled for the year, and for the market size to achieve year-on-year growth of roughly 20%.

That might sound like a lot of issuance in a single year, but remember that in 2017 catastrophe bond and ILS issuance reached a new high of $12.6 billion (by our reckoning), and with 2018 already off to a record start, cat bond market growth of 20% or more seems feasible (at least by our numbers).

“By providing a structural capital solution to the (re)insurance industry these securities are helping to close the disaster gap by supporting the growth and the efficient functioning of the global (re)insurance marketplace. In doing so they provide a measurable beneficial impact on the quality of people’s lives, while generating attractive and truly uncorrelated risk-adjusted returns for investors,” said Seo.

Earlier this week we discussed the 92% of catastrophe losses that go uninsured in Asia Pacific and the fact the economic toll is set to rise to an annual $160 billion by 2030. The magnitude of those figures suggests Seo is right, the reinsurance market alone cannot solve the protection gap and it will take the depth and liquidity of capital markets to meaningfully shrink it.

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