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The cat bond market is attractive, again: SCOR’s Fabrice Rossary


The impacts of 2017 and 2018 catastrophe events on the insurance-linked securities (ILS) market has altered the dynamics of the space, and while volatility with loss estimates needs to be addressed, the attractive risk-adjusted returns on offer highlights the benefits of a structural allocation to the space.

scor-investment-partners-logoThis is according to the recent thinking of Fabrice Rossary, CIO at SCOR Investment Partners, the investment mamagement division of global insurer and reinsurer, SCOR.

Rossary argues that catastrophe bonds, which as shown by the Artemis Deal Directory account for roughly $40 billion of the ILS space, are once again particularly attractive investments.

When compared with other asset classes, notes Rossary, the catastrophe bond market is “currently offering historically attractive returns”.

He explains that over the past 35 years, the average default rate on U.S. high-yield market single B issuers has been 5.5%, with an average loss of 3.3%, and with the risk currently being remunerated at 450 bps above the risk-free rate. In contrast, cat bonds spreads typically range from between 600 and 700 bps for a loss probability of 3%, which is similar to the average historical loss on single B high-yield bonds.

The catastrophe events of 2017 and 2018 served as a test of the ILS space, with many investors experiencing losses for the first time. Rossary highlights this, and notes that following the events market participants suffered a number of different adverse phenomena, including; the loss of capital; trapped collateral; initial loss estimates that worsened; or insignificantly conservative provisioning on the part of certain funds.

The trapped collateral issue has been well documented and according to reinsurance broker JLT Re, an estimated $20 billion of ILS capital remained trapped at the January 1st, 2019 renewals.

Investors in the ILS space are sophisticated and increasingly knowledgeable of the asset class and the underlying risks. The diversification offered through the catastrophe bond market and the very low correlation with broader financial market turmoil continues to attract both existing and new investors to the space.

It’s always going to be a matter of if and not when disaster strikes, and so long as investors are sufficiently educated then a loss of either some of all of an investment at some point wouldn’t have been a surprise.

However, Rossary notes that the impacts of two of the most of expensive catastrophe loss years on record has “eroded investor confidence and generated outflows.” Adding that because the market remains relatively small, at roughly $100 billion (catastrophe bonds and collateralised reinsurance contracts), “the impact on catastrophe bond valuations has been significant.”

After a lacklustre response in 2018 from the prior year events, rates have started to move in a more meaningful and sustainable manner through 2019, with some expecting this to persist into 2020, absent an above average level of catastrophe losses.

“The uncertainty surrounding losses on 2017 and 2018 events is now low, and there is better differentiation among asset managers. The type of investor in this market is changing. Opportunists looking for hedge-fund-type profits are gradually being replaced by institutional investors with stricter selection criteria and a lower appetite for risk.

“This trend is tending to depress management fees and eliminate performance fees. This should amplify the consolidation underway among market participants and raise standards of transparency and valuation.

“Volatility in the estimates of losses incurred by insurance companies and funds nevertheless remains a subject the industry needs to address. In the meantime, funds that protect their investors through temporary asset segregation and a clear valuation policy constitute an attractive value proposition,” explains Rossary.

He concludes that combined with a natural decorrelation with other markets, attractive risk adjusted returns on offer in the catastrophe bond space, “argue for a structural allocation” over a number of insurance seasons.

Track the growing catastrophe bond market and analyse its issuance with the Artemis Deal Directory & Dashboard.

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