Tailor made
The growing insurance-linked securities (ILS) market has encouraged sponsors to thirst for the ‘bespoke’ catastrophe bond, with many seeking longer terms and larger transactions.
The latest of these sponsors to enter the market with a rare term of six months, is AIG. In May this year, the insurer issued Compass Re II, which will cover the US hurricane season.
While a bond of this term is unusual, it has been done before as Paul Schultz, CEO, Aon Benfield Securities, explains.
“We have seen a few short-dated bonds in the past—not for a few years—but we have seen bonds of this type that cover just the US hurricane season,” he says.
Schultz explains that the lack of this type of deal is down to the cycle of the market and spread required from such a short, on-risk transaction.
“When investors consider the pricing level at which they’re willing to buy catastrophe bonds, they will also consider the timeframe that the bond is off and on risk. With a short-dated bond, which is active only while it’s on risk, investors will naturally demand what appears to be a higher spread.
Opting for a shorter-dated bond, which is always on risk, is just an individual decision by the client which aligns to their hedging programme,” he says.
“Also, the bulk of reinsurance is purchased on an annual basis, and catastrophe bonds are typically three years, so short-dated bonds offer the option of a different period of coverage.”
Bigger deals
Another prediction for the future of the catastrophe bond market was the issuance of larger deals. In April, the Texas Windstorm Insurance Association (TWIA) issued a $700 million transaction.
“Generally we’ve seen a steady flow of bonds come to the market; we’re now over $4 billion of issuance for the second quarter. And last month, TWIA launched Alamo Re,” Schultz says.
Following the announcement by the UK government that it will seek to make the UK an ILS jurisdiction, there has been a lot of talk about the pros and cons of the establishment of another jurisdiction.
While Schultz says that the greater the acceptance by regulatory regimes around the world for ILS products, the better the prospects for growth, he also says that transparency must not be jeopardised.
“There are clients that are very familiar, and accustomed to trading, with ILS in certain parts of the world, to the extent that we can make the product even easier to access because clients better understand the regulation and oversight, which helps to facilitate transactions,” he explains.
“However, as the number of ILS domiciles grows, it’s important that we continue to push for the transparency and framework necessary to encourage a robust and secure ILS marketplace. We wouldn’t want to see a new ILS domicile that is inconsistent with established domiciles.
“What we don’t want are problems being created for the industry by mismanaged domiciles, so transparency is really important.”
Secondary market
In the secondary market, pricing remained down in April as the yield that investors demand increases, as Schultz explains.
“On a secondary basis, there are certainly some transactions that are under greater pressure in terms of price than others; it tends to be the low-yielding transactions, and also earthquake covers and aggregate covers,” he says.
“If the return prospects are better when buying risk from the secondary market, investors that have the ability to do so will source their risk from there, rather than buying new issues.”
However, he says, there are some factors to consider when trading in the secondary market.
“First, the secondary market trades in smaller notional sizes—so if you’re looking to put a lot of capital to work, it’s harder to achieve. Therefore, it is advantageous to trade in both,” he says.
“However, ultimately, what will happen is that an equilibrium will be reached between the primary and the secondary markets, and that’s when prices will stop moving one way or the other. That will mean that risk can be sourced from either market for a similar, if not the same, return.”
