Further growth in issuance tends to cat bond market despite price hardening | Analytics

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In its latest report, Aon said it expects Cat Bond market momentum to continue through the second half of this year to match record issuance levels of 2021.

In ILS’ 2022 Annual Report, Paul Schultz, Chairman and CEO of Aon Securities, cited this momentum as a “remarkable achievement given the headwinds the region experienced at times during the first half of 2022.”

Cat bond issuance reached near-record issuance levels of $12 billion from July 1 last year to June 30 this year. The record high of $13 billion was reached the previous year.

“We expect the orderly market to continue and the momentum to continue into 2023,” Schultz added.

Geopolitical factors such as the conflict between Russia and Ukraine, a sudden rise in global inflation, rising interest rates, and currency volatility were all head-on in the first half of 2022, as cat bond spreads increased.

Aoun indicated that the reduced demand for the product “remained strong.”

“While the cat bond market has observed price volatility, it continues to diversify and attract both new and repeat sponsors, with relatively larger increases in (re) pricing of conventional insurance putting the ILS market in a more competitive position year after year,” the report noted.

In the year ending June 30, 2022, Bermuda was the largest home exporter with 41 deals, followed by five from Singapore and three from Cayman, out of a total of 54 transactions globally.

“Pursuit” for more capabilities

Investors have turned to cat bonds as a type of ILS product that provides diversification in their portfolio. This asset class offers relatively attractive conditions, given the frequency and modest severity of disasters.

“The overall theme remains that diversification plays out well compared to previous revolutionary years for the broader financial markets,” said Richard Benay, CEO of ILS at Aon Securities.

“As the space continues to show its ability to offer a source of diversification away from the volatility observed so far in the broader capital markets this year – one can reasonably expect more capital to seek to capitalize on this feature,” he added.

Binay also noted that “the search for more capacity from the ILS market is well underway” for products such as proportional-based sidecars, non-proportional reinsurance via cat bonds or secured reinsurance.

Issuance of catastrophe bonds by year, 2010 to 2022 (years ending June 30)

In the first half of this year, ILS’ capital markets capacity was estimated at $95 billion, down about 2% compared to the same period last year.

But Aon noted that, as a resilient and robust market, ILS’ capacity is in a strong position for the remainder of the year.

“We are now in a market where the demand for ILS capacity exceeds the supply of ILS capital, and while this leads to higher prices and tighter terms and conditions, regular sponsors of ILS products are increasingly grateful for this alternative source of capital, and forging strong relationships with ILS capital markets Money in the process, Binay added.

Separately, Moody’s said reinsurers are increasingly relying on cat bonds and truck sidebars for retro protection as total guaranteed capacity contracted last year as trapped capital re-emerged. According to the rating agency, reinsurers have sponsored 15 cat bonds since June 2021 to reach old capacity, providing a $2.85 billion limit.

Big cat ties

In its latest update to the ILS Market, AM Best reported that the total issuance of real estate cat victim bonds in the first half of this year was $8.1 billion from 35 deals, compared to $8.5 billion from 29 deals in the first half of 2021.

The $5.0 billion put in place in the second quarter of 2022 is down from $5.9 billion in the second quarter of 2021.

However, the report said that 23 – or 66 per cent – of the 35,144K cat bond transactions in the first half were zoomed in from initial guidance levels, totaling a massive $1.6 billion and an average increase of 36 per cent.

Overall, the amount issued in the first half of 2022 was 23 percent higher than the initial guidance.

The report also noted that 23 cat bonds were priced above the midpoint of the initial pricing guidance, while 13 bonds were priced above the upper limit of the initial guidance.

“Pricing in the first half of 2022 contrasts with pricing results in the first half of 2021, when none of the 29 cat bonds issued during that period were priced above the upper limit of the initial pricing guidance, while 20 of the 29 Bonds below the minimum, the report said.

She added: “There were more tranches of cat bonds that could not be placed in the first half of 2022 than in previous years – in some cases, full deals could not be placed. Fifteen tranches in eight deals were marketed to investors but pulled in the first half.” Target amounts for these segments have reached more than $500 million.”

AM Best commented that the reasons for withdrawing cat bonds vary but the inability to place some cat bonds “appears to be related to the broader topic of market hardening”. The rating agency noted that more sponsors never went far enough to market a cat bond because they realized prices and terms would not be favourable.

H1 . Sustainable Cat Association Compound Annual Growth Rate

Meanwhile, Swiss Re Capital Markets (SRCM) noted that the International Labor Standards (ILS) market gave sponsors an alternative source of risk-shifting capacity in a tight reinsurance market.

“Some reinsurers have reduced capacity in peak areas or completely closed natural disaster portfolios, increasing opportunities in the ILS market,” the report said. “Given the need for more comprehensive reinsurance capacity, we expect the trend towards increased volume of new issuances to continue leading to further growth.”

The SRCM said the Cat bond market is on track to maintain its compound annual growth rate, which has been at 8.96 percent since 2012. In mid-2022, there was just over $36.2 billion outstanding.

ILS Market Edition vs. Premium Theoretical

The SRCM said that the net cash flow (new issuance minus maturities) in the market from the beginning of 2021 through the first half of 2022 was approximately $4.9 billion, which it noted helps explain the widening of the spread seen this year.

Net cash flow was also affected by loss payments to sponsors. Payments in the first half of 2022 from loss events in previous years amounted to approximately $230 million, while loss payments in the past four and a half years amounted to $2.0 billion.

The cat bond market in 2022 paid refunds for previous year’s events including Hurricane Ida, Hurricane Florence and Hurricane Michael.

Despite the decline in cat bond issuance in the first half, a handful of new sponsors emerged, with $805 million in cat bond issuance for the first time in that period. New sponsors are Inigo Insurance, Kin, SureChoice Underwriters Reciprocal Exchange, Core Specialty, Peak Re and The Hanover.

The different strategies of ILS managers

AM Best said in its report that investors are evaluating their options, as the financial landscape changes.

“ILS real estate is often touted because of the advantages of diversification, but investors may be willing to forego the benefits if the expected return on another asset is high enough to compensate for the lack of diversification,” the report said. “For this reason, there appears to be a minimum of 6 percent to 7 percent for cat bond margins, regardless of the expected loss level, quality of the sponsor, type of coverage, or other aspects of the transaction.”

A.M. Best commented that ILS managers use different strategies to improve results – “Some emphasize price increases, while others focus on improving deal structures as well as terms and conditions.”

ILS managers believe they can improve outcomes by moving to risk-based, rather than frequency-based agreements. This leads them to contracts in words to focus on the named risks only, writing more contracts at a time rather than total contracts.

“For aggregate deals, ILS managers are more inclined to include per-event caps that limit the amount any individual loss contributes to eroding the aggregate deduction. In some cases, per-event caps are set so that the aggregate facility is not breached even,” the report said. Three to four events occur.

AM Best believes that investors’ skepticism about disaster risk models may prevent them from using additional capital even as prices rise to attractive levels.

The rating agency noted that the first half saw cat losses from floods in Australia, windstorms in Europe, earthquakes in Japan and heat storms in the United States. But ILS directors believe that the underwriting tightening measures taken over the past year should mitigate the impact of these events on ILS investments.

ILS investors are also increasingly optimistic about avoiding losses from Winter Storm Uri in 2021, which caused industrial losses estimated at $15 billion.

More than 130 insurers are jointly suing the Texas Electrical Reliability Board and dozens of power-generating entities for grid failure, increasing confidence that successful litigation or settlement could significantly reduce insurers’ losses.

“Some market participants believe that if large recoveries result from this litigation, the aggregate contracts may ultimately not be related to the layers of coverage,” said AM Best.

ILS returns slightly negative in H1

The SRCM report highlighted that the broader financial markets in the first half weathered the volatility caused by high inflation, the Russian-Ukrainian war and interest rate fluctuations.

Despite these factors, ILS Markets performed relatively well during the first half of 2022 with only slightly negative year-to-date returns for the year and the third most active in the first half for new issues on record.

The Swiss Re Global Cat Bond Total Index showed year-to-date investor returns of -0.35 per cent, with negative yield driven by a difference in points as a result of the widening reinsurance market.

The SRCM said this indicates an improved outlook for returns in the coming years. “Excluding any major natural disasters that could cause major losses, we expect performance to recover strongly in the second half of the year,” the report said.

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