One of the attractive aspects of sponsoring a catastrophe bond is more transparent ‘price discovery’ during the issuance process, something which is harder to achieve with traditional reinsurance negotiations, according to Argo’s Mark Gibson.
Speaking at a Standard & Poor’s event in London today, Gibson Director of Alternative Risk Markets at Argo Group, discussed the benefits and drawbacks of insurance-linked securities (ILS), catastrophe bonds and sidecars during a panel session on the ILS market.
Argo Group has sponsored three catastrophe bonds in the past. It’s first visit to the cat bond market was with Loma Reinsurance Ltd. (Series 2011-1) in June 2011, securing $100m of cover, followed by another $100m through Loma Reinsurance Ltd. (Series 2011-2) in December of the same year. It’s third and most recent cat bond saw Argo secure $172m of cover through Loma Reinsurance (Bermuda) Ltd. (Series 2013-1) in December 2013.
The experience has clearly been a positive one for Gibson, who has actually been in the convergence or ILS space for as long as anyone having taken a keen interest in the CBOT catastrophe options in the mid-1990’s before any cat bonds had been issued.
It’s always interesting to hear how sponsors feel about the cat bond market, what drives them to look for capital markets support in their reinsurance or retrocession programmes, what was positive about the experience, as well as what was negative and Gibson gave a detailed explanation of why Argo has come to appreciate cat bond issuance.
Gibson said that for Argo Group the key driver is for the diversification of its sources of risk capital, outside of the traditional reinsurance or retro market. Alongside diversity of capital, Argo is attracted to the multi-year nature of cat bonds, the fully-collateralized nature of the structures and capital which reduces counterparty credit risk within the firms retrocessional reinsurance program and finally the pricing, particularly the current price point of the market.
Perhaps that hints that Argo may return to the cat bond market in the not too distant future to take advantage of the low pricing, which Gibson said is clearly a major driver for any firm looking to ILS or the alternative markets right now.
Gibson made a fascinating point about price discovery, which is something we have not heard mentioned before in relation to the sponsoring of a cat bond. Gibson said that the ability to have price discovery during the structuring and marketing of a cat bond is key to a sponsor and a real differentiator, as price discovery is not as easy in the traditional reinsurance market.
When sponsoring a cat bond the deal is taken around the investors and there are discussions and negotiations around the level of risk involved, the likely price point and the price guidance is narrowed or adjusted as appropriate. For the sponsor, who is actually seeking the cover, this allows them to understand where the price is likely to close well in advance of the final negotiations.
Gibson also said that price discovery is more difficult when it comes to higher risk transactions, or those down in the working layers of a programme, as often these haven’t been done before. But for the more common transactions, where other deals have come to market in recent times with similar levels of risk and expected losses, it is possible to have a good level of price discovery during the structuring and marketing phases.
There is significant value in this for the sponsor, having a way to discover the cost of the cover, at least to a degree, in advance of closing the deal. This is especially important in a transaction that has been seen in the past as a more costly process to undergo, the ability to discover the (rough) price in advance could be hugely beneficial.
Gibson also said that he views continuity as an important factor when approaching the capital markets or sponsoring a cat bond, hence for Argo once it had sponsored its first Loma cat bond they have become a core component of its reinsurance programme. He also said that it gets easier as each deal passes and that “Once you’ve started, it’s worth continuing.”
Other important features of the cat bond market for Argo include the way the structures have changed over time, bringing more features and better cover as the market has evolved. Gibson said that because of the huge benefits now available to sponsors he expects that the catastrophe bond, as a risk transfer instrument, is set to have a long life. Alongside the benefits to sponsors the attraction for some investors who require liquidity is also set to ensure cat bonds are around for the foreseeable future, he said.
For Argo the continuing acceptance of indemnity cat bonds by investors has been important, as although they are more onerous, complex to transact, have more detailed documentation and require substantial disclosure, the benefits to Argo’s protection are much greater.
A continued drive towards standardisation is important for the cat bond space, Gibson said, particularly as this will help reduce the time to market, something he said requires plenty of forward-planning as it can take a long time to sponsor a cat bond, particularly your first.
On the negative side, Gibson said the inflexibility of a cat bond once issued is something that could be a problem. It’s typically not possible to change the coverage a cat bond provides after it’s issued, except through a variable reset perhaps, but features such as endorsements which are common in the traditional reinsurance market do not exist.
On the costs of issuance, Gibson said that Argo views them as competitive now, and broadly in line with traditional reinsurance when amortised across the multi-year life of a transaction
He said this has been helped by reductions in the bank and lawyer fees, but that this now means that risk modelling costs appear to make up a larger proportion of the transaction costs. That could make private deals, where investors undertake their own modelling, increasingly attractive, especially to smaller sponsors.
Hearing what it is that attracts a repeat catastrophe bond sponsor to the market is extremely useful for those learning about the ILS and cat bond space, who may be considering it as a source of protection. Gibson and Argo’s experience shows that sponsoring cat bonds can be a cost-effective, efficient and not unnecessarily difficult process to undertake.