Net capital inflows from capital market investors into the catastrophe bond and insurance-linked securities space, combined with reduced pricing of new catastrophe bond and ILS issues, helped the cat bond market to grow in the second-quarter of 2013, according to the latest ILS market update from reinsurer Munich Re.
Investors continued to pour new capital into the ILS and cat bond market in Q2 2013, which helped the market to achieve outright growth as issuance outstripped maturities. On Munich Re’s figures, the outstanding cat bond market reached $16.8 billion at the end of June, after issuance of $3 billion outstripped maturities of $2.5 billion.
70% of Q2 cat bond transactions provided protection for U.S. hurricane risks, with the majority of deals coming from established cat bond issuers. Munich Re itself helped out on the diversification side, structuring the Bosphorus 1 Re Ltd. Turkish earthquake cat bond and sponsoring its own Queen Street VIII Re Ltd. containing Australian cyclone risks.
Outright growth for the catastrophe bond and ILS market
The outstanding ILS and cat bond market grew by $1.2 billion over the first six months of the year, showing that investors contributed additional capital to the market this year and the market responded by providing sufficient issuance to beat the volume of maturing cat bonds and help the market grow. The chart below, from Munich Re’s report, shows inflows, issuance and maturities for the first half of 2013.
Reduced catastrophe bond and ILS pricing
As well as strong interest from investors helping new capital to flow into the market, the appetite of investors showed a willingness to accept lower coupon returns for their investments in ILS and cat bond risk, which assisted the market in reducing pricing. This realisation that capital could be deployed for lower cost into ILS and cat bonds made the instruments more competitive with traditional reinsurance and helped to boost issuance.
Munich Re notes in the report that the majority of cat bonds issued during Q2 priced at levels below their initial price guidance. Continuing inflows of capital from investors ensures that every recent cat bond has had excess demand, which has allowed sponsors to reduce pricing below initial expectations for both large and small deals.
Notably, Munich Re cites the example of Bosphorus 1 Re which priced at a risk spread of 250bps for Turkish earthquake risks, a price never before seen in the catastrophe bond market for that level of risk.
Munich Re provides a really useful infographic which shows the issuance volume of Q2 cat bonds and their pricing against the initially marketed range. It clearly shows the reduction in pricing seen throughout the second-quarter of the year and the trend for many of the cat bonds to price below the bottom of the initially marketed range.
Upsizing catastrophe bond and ILS deals
As well as achieving very attractive, or cheap, pricing on many ILS and cat bond deals in Q2 2013, the sponsors who came to market also managed to increase the amount of cover by upsizing the majority of deals. Overall upsizing in Q2 amounted to around 60%, according to Munich Re’s numbers, which is more than the cat bond market has seen in recent years.
Munich Re also notes that indemnity triggers were in favour in 2013, with 71% of issuance placed in the first-half of the year triggering on an indemnity basis. Munich Re puts the success of indemnity figures down to excess liquidity coupled with the dominance of dedicated cat funds on the investor side of the market. The chart below from Munich Re’s report shows the amount ILS transactions upsized by year.
Upcoming catastrophe bond and ILS maturities
According to the report there are a large number of cat bonds scheduled to mature during the fourth-quarter of 2013 and first-quarter of 2014, totalling $2.7 billion of risk capital. Munich Re says that this will lead to strong reinvestment need for investors and ILS funds seeking to keep capital at work and may also result in strong fourth-quarter issuance as many of the deals mature at the beginning of January.
The infographic below, from Munich Re’s report, shows the volume of upcoming cat bonds maturing by quarter, peril and expected loss. As you can see, with only $346m to mature in Q3 we have already outstripped that in terms of new issuance, guaranteeing further outright growth for the ILS market by the end of this quarter. Also, if all of the maturing cat bonds are renewed it could assist the market in clearing $7 billion of issuance based on our Deal Directory.
Looking ahead for the catastrophe bond and ILS market
Munich Re says that it expects sponsors of maturing cat bonds to renew their covers towards the end of 2013. Given the currently attractive market condition,s and with pricing of cat bond and ILS deals at or near lows, it’s likely that the majority of sponsors will seek to renew these deals.
Munich Re says that it expects 2013 issuance to clear $6 billion (bear in mind it does not include mortality or the private deals that others include in their market figures), based on $4.03 billion of issuance for the first half of the year. This would beat issuance from 2012 and on Munich Re’s numbers would take risk capital outstanding to over $18 billion by the end of 2013.
Munich Re believes that the current low pricing we have seen on new cat bond and ILS issues may be the floor, as far as pricing is concerned. Recent secondary market pricing is beginning to show where investors appetites lie and Munich Re doesn’t believe there is further room for reductions in risk spreads. Secondary trading indicates that investors may have reached the low point from where their return targets will not allow them to go any lower.
Munich Re said that it expects the pricing to remain at the low levels we’ve seen so far in 20134, without any further decrease. That will be pleasing for sponsors, and potential sponsors, but perhaps concerning for traditional reinsurers trying to work out how best to compete.
However, the cat bond market remains approximately 70% exposed to U.S. perils, according to Munich Re, and so there is strong investor appetite for diversifying perils. Strong demand for diversification opportunities could lead to reductions in pricing on perils such as for European, Japanese and other risks.
Munich Re notes that the risk placement environment remains favorable for issuing what it terms ‘exotic risks’ and says that this could encourage sponsors to issue deals containing new or unusual lines of business and geographic exposures into the capital markets. That will please investors and potential sponsors alike, as the need to transfer more lines of business via ILS is apparent and now it seems the appetite is there to support these issuances.
You will be able to access a full copy of the Q2 2013 ILS Market Update via the Munich Re website shortly, as well as access older copies from previous quarters.
If you’re travelling to Monte Carlo in September for the Rendez-vous event, Munich Re is holding its regular ILS Roundtable event, titled Insurance-Linked Securities: A market with a bright future, on the 9th of September. Register for the event here.