Swiss Re Insurance-Linked Fund Management

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Increased sophistication of ILS funds to enable more complex catastrophe bond structures


In the latest insurance-linked securities market report from the world’s largest reinsurer Munich Re’s Risk Trading team, the increasing sophistication and reinsurance knowledge of dedicated ILS and catastrophe bond investors is referenced as a development in the market which enables the placement of more complex structures. The market is particularly receptive to diversification opportunities right now, the report says, and has become increasingly receptive to more complex deals.

The report from Munich Re provides another viewpoint on the cat bond and ILS market during 2012, the issuance that occurred during the year and various trends and highlights the reinsurers Risk Trading team observed.

The report states that the relative value that catastrophe bonds provide investors has continued to help drive the market forwards in 2012 assisting it to reach a new record size by the end of the year. Issuance during the year exceeded maturities by almost $3 billion, making it one of the largest growth spurts the ILS and cat bond market has ever seen.

Outstanding and Issued Cat Bond Volume

Outstanding and Issued Cat Bond Volume - Source: Munich Re

The strong liquidity among investors, with many having new inflows of capital to deploy, helped sponsors upsize deals and lock in capacity at very attractive prices. Overall cat bond issuance volumes jumped by 57% thanks to deal upsizing, a sign of what Munich Re termed ‘persistent excess liquidity among investors‘.

Cat bond issuance upsizing in 2012

Cat bond issuance upsizing in 2012 - Source: Munich Re

Commenting on the 2012 cat bond market Andreas Müller of Munich Re’s Risk Trading unit said; “Issuance activity once again exceeded maturities throughout 2012, which has led to a growth of total outstanding capacity and a record market size of $15.6bn. Both well-established cat bond players and new sponsors were active in the market with several issuances, which benefitted from the strong liquidity currently in the market as a result of ongoing capital inflows to dedicated ILS funds.”

Demand for new cat bond and ILS transactions was driven in 2012 by the dedicated catastrophe and ILS investment funds, which had seen a continuous flow of new capital throughout the year as investors sought out opportunities with a better yield than corporate debt markets.

It is these dedicated ILS and catastrophe risk funds which are helping to drive the market forwards in terms of issuance innovation as well, according to Munich Re’s report. The shift away from opportunistic hedge funds to dedicated ILS sector specialist investors has led to a market which is more willing to accept non-standard structures and with a better understanding of the risks it invests in.

ILS funds are becoming increasingly sophisticated and more knowledgeable of reinsurance generally which enables them to work with sponsors to optimise transactions for the cedents coverage needs as well as the funds own investment needs. Munich Re said that the current ILS investor base is well equipped to assess underlying insurance portfolios and the exposure characteristics of cat bond sponsors and deal structures.

This more specialised nature of the investment community is helping the market to change the scope of cat bond offerings somewhat, moving away from straightforward, transparent non-indemnity triggers to use a wider range of customised payout mechanisms based around indemnity triggers, said Munich Re. These structures are more complex and require investors to really do their homework into the underlying portfolio of risk and understand the risk models and exposure data more deeply.

How cat bond triggers have evolved over time

How cat bond triggers have evolved over time - Source: Munich Re

The chart above shows how indemnity triggers have become a much larger proportion of issuance volume over the last few years. The increased knowledge and sophistication at ILS investment houses has assisted with this trend. The trend towards indemnity covers has also helped sponsors to more closely match, and fit, a cat bond with their existing reinsurance towers. The emergence of more cat bonds with aggregate payout structures, second-event coverage and drop-down features is also the result of an increasingly knowledgeable and experienced ILS investment sector.

Looking ahead, Munich Re said in the report that the high cash positions within specialist ILS funds, many have taken more in inflows than they have been able to yet deploy, alongside the increased reinsurance background among funds should continue to allow sponsors to place more complex structures in 2013.

Munich Re believe that the market is extremely receptive to diversifying offerings right now, and said that pricing for these could be particularly attractive as ILS funds have cash-on-hand thanks to strong inflows and investors are willing to accept lower risk spreads for diversifying positions. It believes that excellent placement conditions should be expected for diversifying deals in 2013, noting that this includes U.S. peril cat bonds which have unusual or limited geographic coverage.

For U.S. nationwide cat bond issuances timing will be key, according to Munich Re, citing the upcoming Q2 maturity of $2.5 billion of U.S. peril cat bonds which will return significant sums of capital into investors hands who will be looking for opportunities to put it back into the market. Any insurers targeting cat bond issuance around that time of the year should find placement conditions attractive.

Munich Re said that they expect overall cat bond and ILS issuance volume in 2013 to be comparable with 2012. This will enable issuances to once again outstrip maturities meaning that the overall size of the cat bond market will grow again.

Andreas Müller, of the Munich Re Risk Trading unit said; “For 2013, we expect the market to remain attractive, especially for non-US issuances, which will continue to benefit from the need among investors to diversify their portfolios. Moreover, the market has become increasingly receptive to non-standard structures and indemnity-based triggers.”

You can access the report from Munich Re via their website.

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