Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

January secondary cat bond activity reflects collateralized reinsurance shift


A reasonably active January in the secondary market for catastrophe bonds and insurance-linked securities (ILS) reflected a number of trends, not least ILS investors adjusting portfolios post-reinsurance renewals and a shift towards collateralized reinsurance investments.

January is typically a relatively slow month in the secondary cat bond market, but this year perhaps saw a little more activity which is a sign of the flexibility that investors appreciate thanks to the ability to buy, sell and trade cat bond and ILS notes.

With many ILS fund managers and investors still closing down January renewal deals, finalising all the associated paperwork and shifting collateral around, there is always a need for some portfolio adjustments in January and often February, as investors seek to maintain portfolio diversification.

This year January saw another pressure to trade, the reductions in catastrophe bond yields and the more attractive returns available in collateralized reinsurance making some investors keen to shift out of cat bonds and into collateralized reinsurance investments.

This is one of the trends that has resulted in a large number of short-dated, higher-yielding catastrophe bonds changing hands. Some investors have had to offload these to allow them to move assets into collateralized reinsurance contracts, while other investors have been keen to acquire them as their mandates require the liquidity that cat bonds provide.

That trend has helped secondary trading to a stronger start in 2015 than in previous years. Craig Bonder, Managing Director at AK Capital, commented that his trading desk; “Saw decent flows to start off the year as accounts rebalanced portfolios post year end and 1/1 renewals.”

However Bonder noted that prices had been generally declining in trades in January, and added; “The market seems to be uncertain on whether prices go higher or lower here in 2015. As such should be very interesting to see where we go after so many years of bond prices generally increasing higher and at times trading at substantial premiums.”

This has partially been as a result of the selling activity as investors have shifted to collateralized reinsurance investments in search of a better return, however there does appear some desire to establish a pricing floor and some of the slowdown in secondary pricing may be as a result of this desire, but combined with market forces allowing buyers to demand better pricing from investors who need to sell.

Swiss ILS and catastrophe bond investment manager Plenum Investments noted on the month that; “Secondary market trading activity started quietly in January but then increased somewhat as the month progressed, with the increased primary market activity.”

Plenum also notes that despite the major U.S. winter storms during the month there appeared to be no secondary cat bond market price reactions due storms such as ‘Juno’.

Similarly the European windstorm activity seen in January was insufficiently damaging to trouble any catastrophe bonds, meaning that investors could benefit from seasonal spread development on Euro windstorm positions. This effect is expected to continue through February and into March, until we reach the accepted end of the season for that peril.

Secondary market trading is expected to continue at similar levels through February, with some ILS managers suggesting an uptick will be seen in March as they expect the primary cat bond pipeline to start to flow more rapidly as sponsors seek to get transactions out well in advance of the U.S. wind season.

There continues to be an expectation of strong primary catastrophe bond issuance through March, April and May, but how strong that is remains uncertain. Sources suggest that many primary insurers have been testing the market and enquiring on pricing for cat bonds this year, seeking to take advantage of locking in protection at low prices, but whether they actually follow-up and launch one is yet to be seen.

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