Continued investor appetite for catastrophe bonds and insurance-linked securities (ILS), alongside growing confidence in their use as an alternative to reinsurance, could see the cat bond market hitting $9 billion of issuance in 2015, according to WCMA.
This is according to the latest market report from Willis Capital Markets & Advisory, the capital markets, ILS and M&A focused unit of global insurance and reinsurance brokerage Willis Group, which was published late yesterday.
The broker expects 2015 to be a “memorable year” for the ILS market, with the increased volume of alternative capital that built up in 2014 and growing sophistication in ILS capital’s use helping to propel the market forwards into another potential record year.
In fact, WCMA believes that the volume of capital provided by alternative and ILS markets increased by 20% over the course of 2014. This growth rate is impressive and the additional capital, which has had well documented effects on the reinsurance market, ensures that “2015 is set up to be a memorable year for the ILS market,” the report says.
WCMA says that it would “Not be surprised to see $9 billion of issuance in 2015,” noting that while it took seven years for the ILS market to break its previous annual issuance record that had been set in 2007, it may only take one more year to break the new record set in 2014.
The increasing sophistication in both the use of catastrophe bonds and ILS as well as the investor base means that the gap between traditional reinsurance coverage and ILS solutions is narrowing. WCMA note that 72% of cat bonds issued in 2014 used an indemnity trigger, when only 30% did in the previous record year of 2007.
That evolution, which is continuing, in the coverage provided by cat bonds and ILS means that sponsors are increasingly attracted to ILS as a source of risk transfer and capital. Of course all this growing sophistication and the size of the market also means that spreads are tighter too, making the coverage cheaper but also reducing the available returns.
WCMA expects certain trends set in 2014 will continue into 2015. These include cat bonds continuing to mirror collateralized reinsurance coverage, albeit with a lag. “After all, the capacity is essentially the same, though filtered through different reinsurance products,” the report explains.
How could this impact the market, WCMA asks, perhaps in the re-emergence of retrocessional indemnity deals in the cat bond space. WCMA notes; “Some investors have been using this supposed prohibition to earn outsized premiums on private placements of collateralized re. 2015 may see this end.”
Spreads are expected to keep falling by WCMA, while at the same time the assets under management in ILS will grow in 2015. “Absent a major market moving event, we expect that spreads will decline and AUM will grow,” the report states. But a second trend it expects in 2015 is that the rate of decline slows, something Artemis discussed yesterday here.
Some investors will seek more yield and higher risk deals, WCMA says, but others may follow a beta approach, in search of a transparent, liquid asset albeit with lower risk and yield. The low-correlation factor is likely a key draw for investors attracted to this new and growing area of the insurance linked investment market.
Large cedents could also influence cat bond and ILS issuance, as they could choose to change their reinsurance buying strategies looking for more aggregate coverage and much longer terms, up to 7 to 10 years, WCMA suggests. It notes that Solvency II’s focus on aggregate retention levels as capital measures could help to drive this trend in the future, the report explains.
Clearly what could hinder the market’s continued success and record performance would be large catastrophes that are relatively unexpected to impact ILS but hit cat bonds. However, unforeseen events can now mostly be met with capital, both from traditional rated markets and ILS specialists, so impacts may be more muted than expected.
Adding all this up, with the continued sophistication and growing alternative capital, WCMA’s report says that it expects that “2015 cat bond issuance will modestly exceed 2014 numbers.”
Whether $9 billion is reached depends on many factors, but all the indicators and investor demand are there to suggest that the market can exceed the recently set record.
The report finishes up its intro section; “In sum, we see 2015 as pretty interesting and less predictable than the last two years. While predictable may be good, uncertainty creates opportunity for those who are prepared to act in that moment.”
You can access a copy of the WCMA ILS market report, including more insight, analysis and charts on the market, via its website here.