Private ILS deal prices more stable than liquid cat bonds: Pioneer

Pricing has been more stable in the market for private insurance-linked securities (ILS), such as collateralised reinsurance transactions, than in the liquid catastrophe bond market, according to portfolio managers at Pioneer.

U.S. mutual fund manager Pioneer Investments, which has around $1.7 billion invested in insurance-linked securities and reinsurance linked investments through its multi-asset class fund strategies and its own dedicated Pioneer ILS Interval Fund, believes that more pricing stability is to be found in the less liquid areas of the ILS market.

Portfolio managers of the ILS Interval Fund Charles Melchreit and Chin Liu explained recently that a gradual decline in pricing has been seen in recent years, but more recently some stabilisation in the premiums investors can receive from ILS investments has been witnessed.

“The decline appeared to derive from the lack of any cataclysmic events over the past few years, which has allowed reinsurance companies to build up their capital positions and give them the financial strength to reduce their use of reinsurance or retrocessional contracts,” the portfolio managers explained.

As a result of the decline in reinsurance premiums, the potential returns that investors in insurance linked securities could hope to earn have declined as well, but the Pioneer team see this as particularly apparent with cat bonds.

This situation of reduced returns is seen as “Particularly true for catastrophe bonds sold in public markets, as they are relatively liquid and therefore can come with lower potential premiums offered,” Melchreit and Liu said.

And as a result of the decline in cat bond pricing, the pair say they have “Started to see catastrophe bonds priced less attractively than private placements.”

Conversely, in the private ILS market, where collateralised reinsurance placements and quota shares tend to be king, the Pioneer ILS portfolio managers believe that there has been more stability in pricing in recent months.

In private ILS, the paid say that “We have observed greater stability, primarily in three types of investments: quota share instruments (also known as reinsurance sidecars), collateralized insurance, and industry loss warranties.”

It is a little unusual to see more stability in this private side of the ILS market, as these less liquid instruments are where alternative capital can often come more directly into competition with traditional reinsurance capital at renewals.

But despite the declines in rates and perhaps relative attractiveness of catastrophe bonds, that some in the market have witnessed, the instruments remain in strong demand which is largely the reason for continued declines in prices.

With investor interest in cat bonds so high it suggests that the ILS market needs to produce more risk assets in liquid, securitised form to satisfy this demand.

If it fails to and with such a large volume of catastrophe bonds maturing in 2017, the pricing pressure on the liquid side of the ILS market will likely continue as investors and ILS fund managers seek to re-invest maturing capital as well as any new inflows they receive.

That could make the private ILS space more stable again in 2017, as the liquid catastrophe bond market suffers due to issuance failing to meet demand.

Of course, with demand so high, potential sponsors could be missing a trick to secure reinsurance and retrocession through cat bonds at very reasonable rates this year. Perhaps the brokers will be able to encourage their clients to bring more cat bond product to market, helping to satisfy more of this demand and make prices more stable.