Top five cat bond trends : Q2
Once again, we’ve seen an interesting quarter in the global catastrophe bond market. Usually, that means another record set for original issuance or total limits outstanding. But records stopped being interesting a few quarters ago. Simply accumulating deals doesn’t fully speak to the maturation of the sector. The first half of the year didn’t reach 2014’s record-setting level. But frankly, that isn’t really interesting either. At $4.1 billion in original issuance, the market was robust, as one would expect.
To get a sense of why the first half of the year matters, you need to take a look under the covers. The composition of that $4.1 billion in original issuance could offer some insights for the rest of this year and into 2016. While writing our latest catastrophe bond market update, I found five important trends that could impact the insurance-linked securities (ILS) space, particularly as alternatives to catastrophe bond capacity continue to grow.
1. Taking a breather: issuance was strong in the first half of 2015, with 16 transactions resulting in $4.1 billion in fresh capital. And while that’s pretty far off the first-half 2014 result of $5.7 billion, the first half of this year still became the second most active first half in history — edging ahead of 2013’s result of $3.1 billion. Records don’t matter anymore. It’s clear that insurers and reinsurers are beginning to see the potential benefits that catastrophe bonds (and other forms of ILS) afford, which can help them improve risk and capital management. Simply put, the case has been proved, so we don’t need to rely on big numbers to inspire confidence now. Nevertheless, it’s still natural to ask why issuance activity slowed down.
A few factors appear to have contributed to the lower issuance volume. Collateralised reinsurance has become the fastest-growing ILS category in the market, surging from $7.7 billion in 2009 to more than $30 billion last year. The adoption of cat bond lite — which provides benefits of securitisation without the onerous issuance process of 144A transactions — has accelerated as well, with more than $300 million in publicly revealed deals already this year. New alternatives show that the ILS space is still maturing, and the use of a variety of tools to achieve strategic objectives may reflect continued careful consideration of all available opportunities.
2. “Lite” and sweet: it’s no surprise that the adoption of the cat bond lite structure has gained speed. After something of a breakout year in 2014 — in which publicly revealed cat bond lite deals totaling $242 million were completed — issuance activity has reached $400 million so far this year across 12 transactions. Other private catastrophe bonds (not necessarily issued through a cat bond lite platform) are also being completed as the market seeks new ways to strip out frictional costs while still sourcing the capital and investment opportunities they need.
Given the prevalence of ILS funds in the cat bond lite space, it makes sense that most would use the PCS Catastrophe Loss Index (seven of the publicly announced transactions, amounting to nearly $200 million in new limits). The prevalence of fund transactions, though, also suggests that there’s plenty of room for growth. A broader cedant base, as well as new risk areas, could provide fodder for more activity. Smaller markets could also use cat bond lite as an alternative to 144As, which wouldn’t make sense for smaller transactions (Canada and Turkey come to mind).
3. In the public interest: publicly managed entities have readily adopted catastrophe bonds, but in the first half of 2015, their share of issuance activity was profound. Measured by capital raised, catastrophe bonds from publicly managed entities accounted for more than half of second-quarter issuance and a third of the half-year total — and that with a $300 million Everglades Re transaction instead of last year’s $1.5 billion. Without this segment, catastrophe bond capital raised in the second quarter would have come to only $1.3 billion.
If the use of catastrophe bonds is headed toward niche sectors rather than broad adoption (due to the growth of collateralised reinsurance and cat bond lite), then it would seem that publicly managed entities could constitute a key area of focus. While this year’s concentration of activity is noteworthy, past highlights include the largest catastrophe bond in market history (last year’s Everglades Re) and several other large transactions, including Tar Heel Re ($500 million) and the 2012 Everglades Re transaction ($750 million).
4. Been there, done that: there haven’t been many new faces this year. Only two of this year’s 16 catastrophe bonds came from new entrants (Manatee Re and Azzurro Re I), adding up to $325 million in capital raised. In fact, many of the sponsors we’ve seen this year have completed several catastrophe bonds already. For 2015, at least, it looks like this is a veterans’ market. Since the third quarter is historically slow for catastrophe bond issuance, we’ll likely have to wait until the fourth quarter to see if new entrants will come to the market in significant numbers.
5. An abundance of options: the lack of new entrants may have resulted, at least in part, from the alternatives now available to prospective sponsors. If the frictional costs and regulatory requirements involved in completing a catastrophe bond seem onerous, a sponsor could turn to cat bond lite instead or to collateralised reinsurance. Additionally, the traditional reinsurance market has become increasingly competitive, which could keep potential first-time sponsors from jumping into the market. With a wide range of alternatives for achieving risk and capital management objectives, insurers and reinsurers may not move to catastrophe bonds as quickly as they have in the past. They have other ways to access ILS capital, and decisions will come down to what makes the most sense relative to their strategies — just as it should be.
