Swiss Re Insurance-Linked Fund Management

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Willis Capital Markets see’s very positive ILS market outlook


The insurance-linked securities and catastrophe bond market outlook is very positive in the short-term, according to the latest quarterly ILS market report from Willis Capital Markets & Advisory (WCMA), the capital market division of global broker Willis. The report titled ‘Spreads Continue to Tighten as Sandy Impact Is Assessed‘ looks at the transactions which came to market during Q3 2012, looks ahead to the next quarter and discusses hurricane Sandy’s potential impact on cat bonds which we covered earlier here.

The third quarter is often one of the quietest in the ILS and cat bond market as new issuance slows due to the peak of the Atlantic hurricane season being reached. However this year saw a relatively healthy $525m of new cat bonds being issued in three deals, Munich Re’s Queen Street VI Re Ltd., the California Earthquake Authority’s Embarcadero Re Ltd. (Series 2012-2) and Hannover Re’s Eurus III Ltd. One other transaction is included in our Deal Directory from the third quarter, Swiss Re’s Vita Capital V Ltd. extreme mortality ILS deal, but the WCMA report is only looking at natural catastrophe ILS.

The $525m of new issuance in these three deals took 2012 non-life catastrophe bond issuance to $4 billion, according to WCMA’s numbers. This was helped by the fact that there were no maturities of outstanding cat bonds in Q3.

U.S. hurricane risk continued to dominate the outstanding cat bond market, despite only the Queen Street transaction bringing some new capacity from this peril to market, meaning that at the end of Q3 WCMA saw 72% of outstanding cat bond capacity having some exposure to U.S. hurricanes. There has been a slight drop in that number since WCMA’s end of Q2 report when it was measured as 73%, but we don’t expect that to become a trend unless we see a significant uptick in non-U.S. wind exposed cat bonds (which given Sandy is perhaps now more of a possibility than ever before).

Issuance activity in Q3 was not sufficient to trigger any extensive repositioning of portfolios by investors, which had been a feature of the start of 2012. The secondary market saw steady tightening of spreads and rising prices on outstanding cat bonds as the quarter progressed. WCMA notes that the approach of hurricane Isaac in late August caused some activity, with a number of trades being made as the storm approached although ultimately Isaac did not trigger any cat bonds. One feature WCMA noticed of the secondary market in Q3 was an appetite from investors to increase diversification away from U.S. hurricane risks, as evidenced by the bids being made. As the quarter came to a close, WCMA says that investors were eagerly awaiting the promise of new issuance in the fourth quarter and said that they saw strong pent up demand for new deals.

So in the short-term, WCMA says the outlook for the ILS and catastrophe bond market is very positive. Pricing has been attractive lately, with the tightening of spreads in both primary and secondary markets and strong investor demand leading to very attractive pricing being achieved on recent new issuances.

WCMA understands that the market is still experiencing new inflows of capital looking to take advantage of investment opportunities in catastrophe risk. This is inline with our observations and interest from institutional investors in catastrophe risk and reinsurance seems to remain high. WCMA expect to see a strong fourth quarter of new deals and expect by the end of the year we will have seen $5.5 billion to $6 billion of issuance. Again, their forecast is inline with our experience and market insight.

Bill Dubinsky, Head of ILS at WCMA, commented; “The third quarter is typically a quiet period for new catastrophe bond issuance and 2012 was no exception. But in the short-term, the market outlook is very positive. Spreads have tightened in the primary and secondary markets since the late second quarter and there has been strong investor demand and successful execution at the lower end of pricing guidance. Our forecast for total 2012 issuance remains in the $5.5 billion to $6 billion range.”

Longer term, WCMA says the outlook for the ILS and cat bond market is less clear. In their view the medium term will very likely see significant growth in assets under management, but there is uncertainty over the products and structures this will involve and who will be managing the assets. WCMA expect independent catastrophe funds to remain a core of the market, but expect assets managed by reinsurers (in various forms) to increase over time. This is certainly a trend we’ve seen where by reinsurers are recognising the opportunity to act as asset managers to attract capital and profit from premiums as well. A hybrid approach is becoming the norm for many reinsurers allowing them to operate in both traditional and non-traditional or fully-collateralized markets. They also note that other more generalist asset managers may attempt to get back into the reinsurance sector as reinsurance and catastrophe risk as asset classes reaches critical scale.

The question is how that capital will be deployed into reinsurance and catastrophe risk. We know the interest is there but the cat bond market feels a little constrained. We hope for innovation to allow expansion there but agree with WCMA’s opinion that right now it looks like the collateralized reinsurance space where simpler, private transactions are placed is likely to see more rapid growth. We don’t see this as competition for cat bonds, if anything it is more competition for traditional reinsurance, cat bonds and ILS will continue to play a complementary role. WCMA expects the cat bond market will grow and expand to encompass more risks and also shift towards a greater acceptance of indemnity structures. That is likely, although our opinion is that there also needs to be a great acceptance of other structures, which perhaps have higher basis risk, but can play a very valuable role for both sponsors and investors if intelligently constructed.

Bill Dubinsky said; “Over time we expect the catastrophe bond market will expand to encompass more risks and shift towards a greater acceptance of indemnity triggered structures. However, we expect more rapid growth will continue to be observed in simpler, private collateralized reinsurance transactions.”

Overall the WCMA report is very positive and insightful. You can access a copy via the Willis website here.

Read our earlier article discussing WCMA’s comments on hurricane Sandy’s potential impact on cat bonds.

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