In a roundtable discussion held recently by Standard & Poor’s the participants, from the reinsurance and insurance-linked securities (ILS) space, said that investors have increasingly been drawn to catastrophe bonds and ILS, helping issuance to boom.
2013 saw the highest level of catastrophe bond issuance since 2007 and the second highest level of cat bond issuance since the market began, with over $7 billion of cat bond risk capital issued. Cat bonds and ILS as an asset class are now seen as a long-term investment opportunity, with attractive returns and the added attraction of not being tied to the movements in broader equity and fixed income markets.
Participants in the S&P hosted roundtable discussed some of the reasons that the ILS, cat bond and broader reinsurance investments asset class continues to draw new investors, helping to grow the dedicated capital in the space.
Philipp Kusche, Director of Insurance-Linked Securities at Swiss Re Capital Markets, commented; “From our perspective, certainly, insurance-linked securities (ILS) continue to be an attractive asset class. We have seen, especially from institutional investors, a significant capital inflow over the last two years. Due to the availability of sufficient capital, there is increased confidence from sponsors with the market. They have become more comfortable with the space.”
Structural features have been adapted and changed as the market has found what sponsors want and the best way to make that palatable to investors. This trend of evolving cat bond structures to meet cedent and investor needs helps the market to remain relevant and increasingly attractive.
Kusche continued; “The other item to mention is the increased investor acceptance of indemnity triggers and other structural features. For example, flexible resets, which were recently introduced, and aggregate solutions generally have supported the deal flow this year. We expect this trend to continue.”
Mario Rizzo, Senior Vice President and Treasurer at U.S. insurer Allstate, agreed that investors increasingly find the asset class appealing; “Given the continued low interest rates and investor demand for yield, these types of products fit nicely, as they’re non-correlated risks, particularly for investors that might have a longer investment horizon. When you compare the yields of these instruments to those of traditional corporate bonds or other traditional investments, demand has picked up. What we saw is that you have traditional cat bonds investors but also, relative to when we did our last transaction back in 2007, there were a lot of new investors interested in this asset class.”
Rizzo represents a potential sponsor for the cat bond market and acknowledged that the growing capital levels in the space, along with the increased flexibility in deal structures are attractive; “The combination of those two features–the one that Philipp talked about from a structural perspective as well as the investor base expanding and the overall yield environment–really contribute toward a positive issuance environment for a company like Allstate or any other sponsor.”
The range of investors providing capital to the ILS space is growing, according to Rizzo, who said; “In both the ILS and the collateralized spaces, there are more parties fronting new sources of funds. The influx of capital–coupled with traditional players expanding their business model–is creating the innovation that Phillip spoke of.”
The increased size of the ILS market is helping to drive forward innovation in deal terms and structures, said Rizzo, a trend he expects will continue; “I have heard of ILS opportunities that are multi-event, and I’ve seen collateralized markets that will now do multi-year offerings. As this market garners more capacity and more pressure to expand, I expect the innovation to continue.”
Rhodri Lane, Manager of Insurance-Linked Securities at risk modeller AIR Worldwide, said that as investors have got more familiar with the asset class more capital has been flowing into the ILS sector; “On the investor side, it seems many of the investors, including multi-asset class investors, have gotten more comfortable with the space over the past few years and continue to be enamored with the higher yields and low correlations cat bonds offer.”
The continuing evolution of the ILS and catastrophe bond space is also causing changes in reinsurance buying habits, explained Lane, with structures like cat bonds now receiving equal consideration to traditional reinsurance cover.
Lane explained; “We’ve definitely seen heightened interest over the past few months. What’s interesting, now, is that cedents have gone out to explore acquiring reinsurance capacity earlier than typical years; at the same time, they’re also exploring the securitizing cat bond capacity, and so they’re doing some parallel explorations. We’ve received inquiries just as sponsors have gone out and tried to feel out what they might be able to secure from traditional markets or the ILS market as they approach the end of the year. Securitizing doesn’t seem to be an afterthought to core reinsurance program purchases.”
Mike Demetre, Senior Vice President and Chief Risk Officer at Allstate Protection, said that the ILS market forces innovation and this in turn results in changes to business models, both among the traditional reinsurance players and the ILS specialists.
Demetre said; “Many of the traditional reinsurers have decided to become third-party providers. In some ways, they are trying to blend their own business model to avail themselves of a lower cost of capital that the investors backing the money will allow while still taking fee income. I see pressure and options offered to access sidecars or nontraditional capital in a way that appears and feels like the traditional markets. As the innovation that we see and talk about happens, there are shifting business models and appetites. ILS money and the third-party capital providers know that they need to transform their offerings if they want to increase their market share.”
But the traditional market has not been taking this assault on core areas of their business lying down, attempting to fight back with changes to their own offerings to make them more attractive to reinsurance buyers. This in turn results in more options for protection buyers.
Demetre continued; “As a response to that threat, reinsurers are protecting their space and pushing innovation through what they can offer that differentiates them from that type of capital. It is a healthy dynamic right now, though some people in the reinsurance space might not feel that way. From my perspective, it has given me more options and better pricing to do different things with my reinsurance programs.
Allstate sponsored the $350m Sanders Re cat bond in 2013 and found pricing and the terms available to it extremely attractive.
Rizzo said; “Pricing becomes the initial draw to the market given the relative spread between traditional market and cat bonds at various layers of our reinsurance program. Looking beyond pricing as an issue, we also like the tenor. We were able to get a four-year transaction done; we like that stability in the market. Again, this gets at some of the new and innovative features. For example, we like having a longer time horizon on our risk-transfer program, and diversification does matter.”
Rizzo does not see an issue in their being healthy competition between ILS and traditional reinsurance. In fact he sees this as a positive for Allstate as a sponsor. He explained; “Creating healthy tension between the traditional market and the alternatives, particularly as the alternative market grows, gives us more options and is a positive factor from an sponsor’s perspective.”
One potential issue for the market is raised by Swiss Re’s Kusche, who says that investors need more liquid assets and cat bonds meet that need. Right now the ILS market is perhaps not producing enough assets to meet investor demand for cat bonds.
Kusche explained; “We often hear from the ultimate end investors that although there are a large number of products out there, many of the institutional investors have a preference for cat bonds given that it is a liquid and traded instrument. This aspect is valued by the end investors, who either invest directly into the market or through dedicated funds. We have to observe how this plays out over the next few years.”
The roundtable participants were asked whether they felt ILS and third-party reinsurance capital would be sticky in the event of significant losses hitting the reinsurance or catastrophe bond markets. Rizzo from Allstate explained that investors are already moving into the riskier layers of reinsurance programs and that this must mean that they expect to take on some losses occasionally.
He responded; “From what we’ve been told and what we’re hearing in the marketplace, investors are seeking more risk because the return is higher than the return on remote risks. Whether that capital is sticky or not remains to be seen. But, in my view, if they’re willing to play in more of the belly of the risk curve as opposed to the tail, there’s an expectation that there will be losses. Provided investors are comfortable that they’re being compensated for that risk, they would be willing to reinvest over time.”
Demetre agreed that investors in ILS and cat bonds are likely to stick around, saying; “The managers who are flowing capital into this space are investing 0.5% or 1% of their overall portfolio. Even at a total loss, given their investment is such a small piece of their overall, diversified portfolio, the expectation is there won’t be the re-up transaction shock as we saw in traditional markets in 2005 to 2007. The expectation is the money’s here, and it’s probably going to be here to stay.”
Kusche agreed, adding that the decision to invest in ILS is typically strategic for the large institutional players, not simply a hunt for yield. He commented; “Those investment decisions were made at a strategic level and ultimately led to an investment into the ILS space, which makes this sticky money rather than money coming in and then going out after an event. Investors clearly understand that one reason why this is a diversifying noncorrelated asset class is that you can have a principal loss following a cat event that is unrelated to the equity and fixed-income markets.”
Looking ahead, the panelists said that they expect another positive year of issuance in ILS and catastrophe bonds in 2014.
Swiss Re’s Kusche said; “From our perspective, if the conditions remain as favorable as they are now, we would expect that 2014 will be another positive year. A lot will depend on how many sponsors will utilize the ILS market versus the traditional reinsurance market.”
Lane from AIR Worldwide added; “Activity continues to indicate growing demand for the asset class–from both capacity buyers (sponsors) and capacity sellers (investors). Second, there are approximately $6.5 billion worth of bonds maturing between today and the end of 2014, and more than half that matures before the end of June 2014. Given the current environment, it seems like that’s a lot of capacity to replace, and I wouldn’t be surprised to see a higher issuance amount closer to $8 billion in 2014 just given those metrics.”
Subscribers can access the full structured credit roundtable transcript from the Standard & Poor’s website.