Swiss Re Insurance-Linked Fund Management

Xactanalysis Insights and PCS

Slower secondary market signals capital waiting for new catastrophe bonds


Last month the secondary catastrophe bond market slowed down, with trading volumes dropping considerably from the relatively active August according to market participants. The slowdown has a lot to do with seasonality, having just passed the peak of the hurricane season, and with no real impact from any storms, cat bond investors and traders are now looking ahead to the pipeline of new cat bond and ILS deals which they expect to come to market during Q4.

In our article from yesterday, one ILS investment manager (the LGT ILS team) said that while September may have been slow in the secondary market there remains substantial investor interest in the cat bond and ILS asset class. The trend suggests that investors appetite for cat bonds has not been satisfied, rather they are waiting out the current high secondary prices in favour of expected new deals.

A second insurance-linked securities investment manager, Swiss based Plenum Investments, has echoed this in their latest monthly managers commentary. Plenum said that activity in the secondary market was low in September but that this signals that excess cash is waiting to be deployed into new transactions. This will please sponsors of Q4 cat bonds who will be hoping that the trend for cheaper pricing that we’ve seen in recent deals, where many recent cat bonds have priced below guidance, will continue into Q4.

The idea that capital is waiting on the sidelines to be deployed into the sector is nt just evident from the secondary cat bond market. There are a number of catastrophe funds and ILS managers who have raised funds in recent months but have not, as yet, deployed it all. Some will be waiting specifically for the new cat bond deals that come to market, while others will be waiting to also see what the January reinsurance renewals bring. Depending on an investment managers strategy they may choose to deploy their capital where the best return can be achieved, or they may deploy capital based on diversification opportunities. Q4 should satisfy both strategies, with a number of diversifying peril cat bonds expected as well as some peak U.S. wind deals at the end of the year.

With the reinsurance renewals expected to be relatively flat in terms of price increases this year, with some expecting declining rates in non-peak regions, cat bonds may prove to be a very attractive destination for capital in Q4. Retrocession will likely be the other winner at these renewals as the rates achievable there will likely be more attractive.

Where ever the capital goes, it is clear from discussions with investment managers, reinsurers and providers of collateralized capacity that there is plentiful capital available to support robust cat bond issuance as well as the reinsurance renewals. This capital waiting on the sideline could of course influence rates even further, perhaps tempering any rate rises completely and keeping cat bond issuance costs very competitive.

Plenum said that during September they saw continuing spread tightening on U.S. hurricane exposed cat bonds, with prices increasing by an average of 1.6% accross U.S. hurricane cat bonds, as calculated across 4 pricing suppliers. U.S. earthquake and Japan quake cat bonds stayed flat, reflecting the lack of a seasonal influence for those perils. Jaan typhoon bonds gained by about 40 basis points while European windstorm positions decreased approximately 20 basis points.

Q3 saw four cat bonds come to market, totalling approximately $800m of issuance. Plenum said that the 3rd quarter typically accounts for 15% of a years transactions. This year it’s sitting around 16% to 18% depending on whose numbers you look at, so we’re still on track with issuance at least equaling average levels. Promisingly, Plenum said that the 4th quarter averages around 45% of a years total issuance, which would see the year around the $6.5 billion mark if that percentage applies to Q4 2012 as well. Plenum says that this level of issuance would be positive for the cat bond market and would help to bring more liquidity and a broader range of deals to the market. That liquidity and variety of transactions is becoming more important as increasing levels of capital and investor interest sit on the markets sidelines.

Plenum Investments recorded another strong month of performance within their fund, achieving a monthly return of 1.06% in the USD class which takes their year-to-date return to 5.31%. They expect October’s performance to be only marginally lower as spread tightening on U.S. hurricane cat bonds slows slightly, but still allows them to book another month of seasonally uplifted returns for their investors.

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