Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Secondary catastrophe bond market behaves seasonally in August


The secondary market for catastrophe bond and insurance-linked securities notes saw typical seasonal activity in August apart from a notable lack of any threat from U.S. hurricanes. Seasonality has seen U.S. wind cat bond spreads tighten, despite the lack of any U.S. wind so far this year.

After a few months where the effects of capital inflows and investor interest in ILS and catastrophe bonds skewed the seasonal trends in terms of price and spread movements, the secondary cat bond market settled down into a more typical pattern in August. Supply in recent months appears to have satiated some of the excess demand seen earlier this year, however this is expected to just be a lull with demand expected to return in force later this year when primary cat bond issuance picks up again.

August saw typical spread tightening on U.S. hurricane exposed cat bonds increase, as is expected when we are moving towards the expected peak of the Atlantic hurricane season. This spread tightening will be welcomed by funds with large allocations to cat bonds, or a total focus on cat bond notes, enabling a better performance for them.

At the same time ILS funds which invest in collateralised reinsurance instruments and private contracts will be expecting better performance from August as well, as the returns from those contracts often provide higher profits during the peak of the hurricane season.

This is evident by looking at the ILS Advisers Index, which tracks the performance of 30 constituent ILS funds. So far for August, with over three-quarters of the constituent funds having reported, the ILS Advisers Index reports an average ILS fund return of 0.66%. We’d expect that percentage to be higher once the final fund returns are calculated in a week or so.

ILS investment manager Plenum Investments commented on the secondary cat bond market; “Spread tightening on US hurricane CAT bonds pushed up prices in August, which is in-line with the expected pattern, where prices of bonds firm during the respective risk season. The same seasonal effect caused prices of bonds exposed to Europe winter storm risk to drift slightly lower as we are outside the risk season for this peril. The return of seasonal effects as determining factors for price movements also indicates a more balanced
relationship between supply and demand. Imbalances between the two have led to unseasonal price movements in the past few months.”

Demand and supply have been important factors to consider in 2013, with demand for cat bond positions as well as supply of primary cat bonds causing unseasonal price patterns. High demand has also enabled some investors to profit on cat bond positions, even to the extent of buying a new primary issuance only to sell it shortly after for a premium in the secondary market. This has led to unusual trends and we will likely see more interesting trading patterns later in the year when primary issuance picks up again.

Secondary cat bond trading in August was slower than July, perhaps due to slower primary issuance leading to less requirement for ILS investors to balance portfolios. Volumes are expected to remain low in September unless any hurricanes threaten creating a need for repositioning and perhaps offloading of notes.

Craig Bonder, Managing Director and Head of ILS Trading at AK Capital, said that while actual executed trading volumes were lower in August, demand for catastrophe bond positions remained high in the secondary market. Bonder said that the lower primary issuance, time of year with market participants taking holidays in August and the very benign hurricane season resulted in less sellers active in the market, which helped to push up prices further.

Another trader from a well-known reinsurer told us that its secondary cat bond desk saw strong demand from newer investors in the ILS space, but again the volume of sellers was not large enough to result in high levels of executed trades. We were also told that there are investors in the ILS space who still have capital inflows secured in the first-half of the year to deploy, as they try to hit their target levels of cash to invested assets.

So in August there seem to have been two sides to the market. The usual suspect ILS investors have not had as great a demand for secondary cat bond positions, due to lower primary issuance so less requirement to balance portfolios, as well as many holidaying. Meanwhile there has still been some strong demand for positions, but these have been from newer investors to the space and those still with capital inflows to deploy.

This does bode well for activity when primary issuance picks up, as new deals should see strong demand and also stimulate more liquidity across the secondary cat bond market.

So far, with September also looking like a benign month in terms of hurricane impacts and much slower primary cat bond issuance, secondary catastrophe bonds are expected to follow seasonal patterns. We’ll update you again when the full returns are in from the ILS fund managers for August and with more on the secondary cat bond market in weeks to come.

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