The year 2012 saw the highest level of indemnity trigger based catastrophe bond issuance on record, with more than 50% of all cat bond volume issued exposed to the indemnity losses of the sponsoring insurer or reinsurer, according to data from Swiss Re’s latest insurance-linked securities market report. The report suggests that this shows that cat bond investors are prepared to help sponsors reduce basis risk, if the compensation is attractive.
The use of indemnity triggers in cat bond transactions has followed an unusual pattern since the markets inception in the mid to late 1990’s. In the late 90’s indemnity triggers were all the rage, with around 70% of cat bond issuance in 1997 indemnity based, almost 100% in 1998 and over 50% in 1999. Then indemnity triggers lost favour for a few years, as index triggers and parametric structures became more desired, until the late 2000’s when indemnity trigger use picked up once again. See the data on this trend in one of our articles from 2009 here.
Some of this trend was driven by market conditions, both in the traditional reinsurance market and financial markets, as well as both investor and sponsor appetites and requirements. Swiss Re said in the report that the marked increase in indemnity triggers in 2012, more than double 2011’s indemnity trigger issuance, suggests that investors are willing to help sponsors minimise basis risk if they are adequately compensated for the increased uncertainty.
In 2012 Swiss Re recorded $3.2 billion of cat bond issuance which utilised indemnity triggers, compared to just $1.4 billion on 2011. So of the $6.3 billion of cat bonds issued in 2012, more than half was exposed to the sponsors indemnity risks. The graph below from the report shows indemnity cat bond issuance volume for recent years.
2012 saw experienced cat bond sponsors shift their repeat issuance from the trigger types used in prior years to use indemnity triggers, with 2012’s Mystic Re III Ltd. (Series 2012-1) and Long Point Re III Ltd. (Series 2012-1) both examples where the prior years deals had been industry loss based.
From the investor’s perspective indemnity triggers mean a requirement for more disclosure around the underlying portfolio of risk involved in a cat bond deal, the sponsors underwriting process and also around the way ultimate net losses are to be reported. Swiss Re said that it has noticed changes in the disclosure level offered by repeat indemnity cat bond sponsors. One area this was evident is the disclosure of the Subject Business within offering circulars, according to Swiss Re. Citing the recent Lakeside Re III Ltd., Swiss Re said that the Subject Business portion of the offering documents increased from 7 pages in Lakeside Re II to 45 pages in Lakeside Re III.
This enhanced and increased disclosure allows investors to better assess transactions, give their opinion on pricing more comfortably and better equip them with respect to making investment decisions. Investors are becoming much more sophisticated, able to comfortably model transactions themselves, so this increased disclosure makes sense at this time. Swiss Re notes that indemnity bonds tend to have higher yields, so with investors better able to assess these deals the attraction of a better yield may go some way towards explaining the increase in indemnity trigger usage.
Finally, the chat below from Swiss Re’s report shows that indemnity triggers now dominate the outstanding cat bond market, with 51% of cat bond risk capital outstanding having used an indemnity trigger. It’s clear that investors are now so comfortable with indemnity based cat bond risk that this portion of the market will continue to grow. Which of the other trigger types continue to grow their contribution to the market will be most telling over the years to come and may hinge on new perils coming to market which are better suited to index or parametric based triggers.
Read our other articles on Swiss Re’s recent report: